Debt

Debt is the idea that one party owes something to another party.

Debt Currency

A currency is something which flows between two or more parties.

A debt-based currency is a currency backed debts;

All of the world’s central bank currencies are debt-based currencies. This type of money is referred to as “fiat” money, as its value depends on trust in the issuing government and economic system.

The purchasing power of the currency is tied to the estimated value of an array of third-party debt obligations, such as bank loans, mortgages, credit card balances and more. A currency’s purchasing power is also tied to its value compared to other world currencies in any given moment. For a global reserve currency such as the US Dollar (USD), its value also benefits from its use in settling commercial transactions between currencies globally.

Abracadabra: Debt-Based Currency is Created

Debt-based currency is created through US Government spending and bank lending.

When a commercial bank issues a loan, it generally creates a new deposit in the borrower's bank account at the same time. It is in this moment that new money is created and placed into circulation.

The borrower receives money that can be spent, while the bank receives an asset. The bank’s asset is the borrower's debt, or promise to repay. The borrower’s newly created deposit is an obligation of the bank.

The person who owes has an obligation. The person who is owed has a claim.

And so, money and debt are created together. The purchasing power of the money and the value of the debt are instrinsically tied to the same thing: borrowers’ willingness to pay — and investors’ confidence that they will.

The money created by the loan may move from person to person throughout the economy, even though the original borrower’s obligation may or may not be repaid. If the loan ultimately defaults, the asset price of the debt obligation held at the bank declines.

Bank Money and the Movement of Debt

A brief recap. Imagine a bank approves a USD 100,000 loan.

The bank does not normally need to find another customer's USD 100,000 deposit and hand it to the borrower. Instead, it creates new currency and records two things at the same time:

The bank receives:
A USD 100,000 loan asset—the borrower's promise to repay.
The borrower receives:
A USD 100,000 bank deposit that can be spent.

A loan asset is created for the bank, while money is issued to the borrower.

The borrower can now use that USD 100,000 to buy a car, pay a contractor, purchase equipment or make another payment.

Now, suppose the borrower pays the entire USD 100,000 to another person.

The money moves.

The debt does not.

The recipient now has the USD 100,000 deposit, while the original borrower still owes USD 100,000 to the bank.

This is one of the most important features of bank money:

Money created alongside a debt can circulate independently of the borrower who incurred that debt.

When the borrower eventually repays the principal of the loan, the process reverses. The borrower's money is reduced and the bank's loan asset is reduced. Bank-created deposit money is therefore created through lending, and extinguished through repayment of principal.

Here is another important point. When the borrower makes payments using that USD 100,000, funds may transfer from the borrower’s bank to another bank. When a bank transfers a borrower’s deposit to another banking institution, it credits the receiving bank with a deposit reserve held in its name at the Federal Reserve.

Why?

Remember, deposits are a liability for the bank. If a bank transfers its liability to another bank, it must also provide that bank its assurance that it will pay for that liability. That assurance is the deposit reserve. The Federal Reserve holds deposit reserves on behalf of commercial banks. It may be helpful to think of these deposit reserves as highly liquid savings accounts for commercial banks.

Debt Securitization

A debt does not have to remain a private agreement between the original borrower and lender.

Remember, the lender's claim is considered a financial asset.

Imagine that Party A owes Party B USD 100.

Party B possesses something potentially valuable: the right to receive USD 100 and more, assuming interest and fees are accruing.

If that claim can be legally recorded and transferred, Party B may be able to sell it to Party C.

Now:

Party A still owes USD 100.

But Party C owns the claim.

This simple idea is one of the foundations of modern finance.

Over centuries, societies developed increasingly sophisticated ways to record, standardize, transfer, and trade claims on future payment. Debts such as credit card receivables, student loans, auto loans, business loans, and more, are all frequently sold into securitization vehicles or other forms of debt instruments. The securitizations are treated as assets and then used as collateral for additional borrowing.

The estimated value of these debt vehicles and revenue from servicing the loans within them, may support an entire publicly traded company, which then issue equity shares, and additional forms of secured and unsecured debt.

Derivatives and derivative exchanges can create additional contracts whose values are pegged to interest rates, bonds, loans, defaults and other financial claims, such as currency exchange rates.

As one might imagine, the quantity of financial claims can expand much faster than the underlying real assets and borrowers’ future capacity to pay. One borrower’s future promise to pay could set the foundation for countless additional claims. For example, one borrower’s mortgage loan could serve as the basis for claims from the original lending bank, securitization noteholders, a derivative counterpart, a mortgage servicer, a mortgage servicing company’s debt, a derivative index, and more.

During good times, this can create enormous liquidity. But every financial claim ultimately contains an assumption about somebody else's future capacity to perform.

The mortgage assumes the homeowner can pay and home values will remain stable or rise.

The mortgage-backed security assumes enough mortgages will pay.

The secured debt assumes the collateral will retain sufficient value and/or the borrower can repurchase it.

The derivative assumes counterparties can perform.

The Treasury assumes future fiscal capacity.

In one way or another, all of this debt backs the US Dollar. The dollar’s value depends on an intricate web of debt valuation.

The size and complexity of the existing global debt market keeps enough payments changing hands in order to maintain demand. The greater the volume of debts (assets), the greater the volume of money (deposit obligations) which must be created to fulfill them.

Do debts always need to grow in a debt-based monetary system? Yes and no. Debts typically continue to rise in size — and complexity — as a result of a little thing called interest. When the original principal balance of a debt accumulates interest and fees, more money must be created to pay off the obligation over time. When debt value collapses as a result of lost confidence, delinquency or default, all of the claims on that debt subsequently collapse in sync.

While the value of the debt declines, the same amount of money remains in the system. That money may be reabsorbed into the system through higher interest rates or reduced government spending.

Debt in the Global Financial System

Both US debts and US debt currency are circulated throughout the global economy. The USD makes up roughly 56% of global currency reserves, and nearly half of all physical US currency is held internationally.

Foreign investors hold:

30% of US corporate credit and debt markets, and between 20% and 40% of US corporate equities;
24% - 31% of US Federal debt;
and 15% - 20% of all US mortgages.

Payment from all of these debts, along with proceeds from equities and any other direct US investments made by foreign investors, typically arrives to foreign investors in USD. At this point, a foreign investor can either hold the USD or convert it into a local currency.

Why does this matter? In order for the USD to leave a bank balance sheet, it must have a buyer/receiver. If demand wanes for USD, or a glut of conversions are requested at once, the price at which a buyer is willing to purchase the USD may fall, creating a weaker currency. Similarly, a shortage of USD sellers could lead to higher exchange rates.

Currency swaps hedge the price of currency exchange rate fluctuations across a specified time period. Approximately USD 14trn of currency swap (FX) obligations are settled on a given day. Meanwhile, 9.6trn of FX trades occur daily — and 89% of these include the USD.

Since the 1950s, non-US banks can originate USD-denominated loans, securities, and other obligations. These are called Eurodollars. Dollar credit in the form of bank loans and international debt securities to non-bank borrowers outside the US was USD 14.3trn at the end of 2025.

An offshore bank can create dollar-denominated deposits for its customers without the Federal Reserve simiultaneously creating an equivalent amount of reserve balances. Remember, reserve balances are created when one US bank transfers a deposit (liability) to another US bank. The reserve balance serves the purpose of offsetting the liability of the deposit transferred from another bank. Dollars that originate within the US banking system are considered Federal Reserve money, are insured by FDIC deposit insurance, and subject to US banking rules and policies.

Offshore dollar claims are not subject to those rules, and can circulate, be transferred and remain outstanding without being continuously converted into Federal Reserve money. However, when offshore institutions require settlement through the US banking system — such as when a borrower transfers Eurodollars to a US bank account — they it’s obtain dollar funding. This is because the Eurodollar was created outside of the US banking system, and a non-US bank cannot transfer a liability to a US bank without also providing deposit reserves. The Eurodollar must be traded for a Federal Reserve USD through some form of trade, perhaps via a correspondent bank.

And so, while the Federal Resrve control the ‘apex’ dollar settlement asset, it does not directly control the total quantity of dollar-denominated financial claims that the global private financial system can construct beneath it. Taking into account all of the claims created when a single debt is created, along with dollars creation abroad, the global dollar system can become much larger than the Fed’s own balance sheet. In a crisis, a scramble upward through that hierarchy has historically resulted in a rush for central bank dollars.

With all of these complexities, why is one country’s currency the predominant settlement mechanism among international trades?

Global Reserve Currency

Every country can issue and use its own currency domestically. International trade creates a different problem: which currency should countries use when transacting with one another?

If a company in Brazil buys machinery from Germany, the parties do not necessarily want to hold each other's currencies. Banks, corporations and governments therefore benefit from having currencies that are widely accepted internationally.

For much of the modern era, the USD has performed this role more than any other currency. It is considered the predominant global reserve currency. A global reserve currency tktktk.

The dollar is used internationally as a unit of account, meaning goods, contracts and financial instruments can be priced in dollars. As a medium of exchange and settlement, it can facilitate transactions between parties that do not use dollars domestically. It is also used as a store of value and a reserve asset, meaning governments, central banks and private institutions hold dollar-denominated assets for future use.

The dollar's international importance is considerably greater than the United States' share of the world economy. While the United States constituted about 26% of global nominal GDP in 2024, the dollar represented roughly 65% of international currency usage, according to the Federal Reserve. The dollar represented about 58% of disclosed official foreign exchange reserves; that number has since declined slightly.

If two parties simply trade in dollars — such as Eurodollars — transaction costs are reduced. Participants do not have to construct an entirely separate monetary relationship for every international trade.

However, when the world’s most widely used international currency is also the domestic currency of a single country. United States debt of all kinds is circulating around the world as a medium of exchange and a store of value.

How did this happen?

The dollar's position was formalized internationally through the Bretton Woods system in 1944. Under Bretton Woods, participating currencies maintained fixed exchange-rate relationships with the dollar, while the United States committed to convert dollars held by foreign official institutions into gold at USD 35 per ounce.

The dollar became an intermediary between national currencies and gold. Instead of every country needing to settle international balances directly in gold, countries could accumulate dollar claims. The arrangement was struck in part due to the economic position of the United States after World War II. The United States possessed a large and productive economy, substantial gold holdings, and increasingly deep financial markets.

Today, the dollar's position rests heavily upon the size of the US economy, the depth and liquidity of American financial markets, confidence in US institutions, and the enormous stock of liquid dollar-denominated assets available to global investors.

Even though roughly half of US physical currency exists offshore, foreign central banks typically hold dollar-denominated financial assets, such as government securities and deposits.

Central banks generally hold dollar-denominated financial assets, especially government securities and deposits, rather than simply physical currency, in order to benefit from interest. A US Treasury is an asset to its holder and a liablity to the US Government, just as a dollar bank deposit is an asset to the depositor and a liability to the issuing bank. An offshoredollar deposit—traditionally called a Eurodollar—is an asset to its holder and a dollar-denominated liability of the offshore bank.

As the post-WWII economy expanded, the international community needed an increasing supply of USD reserves. The demand for reserves — many of which were dollar liabilities convertible into gold — outpaced the US gold supply.

Part of the reason why the USD transitioned into a debt-based, or fiat, currency when the gold convertibility failure was uncovered, was similar to the situation we face today. By 1971, the USD was immeshed in the global financial system through a vast network of trade agreements, debt obligations, and equity holdings. The USD made up an all-time high of 80% of global currency reserves. Pulling back dollars could result in a “global contractionary spiral,” according to the International Monetary Forum’s historical account.The US also tied for global military strength with the Soviet Union at the time. Unwinding the USD position due to its gold convertibility failure could have not only severely disrupted the global economy, but pull the rug out from under the USD’s increasing global dominance.

While the USD is no longer convertible into gold, its strength relies on an expectation that the payment obligations which back it will be fulfilled. A debt-based global reserve currency system contains feedback mehanisms that can become increasingly difficult to sustain if financial claims and the cost of servicing them grow faster than the productive, fiscal, human and environmental capacity supporting those claims.

Bancor

Concepts such as the Bancor and SDR are currency settlement mechanisms that bypass the need for a global reserve currency. Prior to the establishment of the Bretton Woods system, British economist John Maynard Kenes proposed an International Clearing Union that would use an accounting unit called the bancor to settle trade imbalances. Similar to the way in which US commercial bank reserves operate between commercial banks and the Fed, the bancor would operate primarily between countries and their central banks.

The Clearing Union would act like an international settlement ledger designed to equalize global trade imbalance.

Imagine Country A buys USD 100m more goods from Country B than Country B buys from Country A. Today, international settlement may generate demand for dollars and corresponding financial assets, such as Treasurys. This means that Country A must find a willing buyer for its currency, in order to exchange it for dollars. Or, it must attract dollars some other way, like selling natural resources.

Under a simplified clearing-union system, the international institution could instead record the imbalance on its common ledger. There would be no need for Country A to somehow source dollars.

Instead, Country A develops a debit position, while country B develops a corresponding credit position.

Keynes's proposal allowed countries access to bancor overdrafts within quota limits, giving deficit countries room to adjust rather than requiring every temporary external deficit to produce an immediate contraction for that country’s currency.

Ordinarily, international adjustment places enormous pressure on the debtor country. If a country persistently imports more than it exports and exhausts its foreign reserves, eventually it must adjust. Meanwhile, the country accumulating persistent surpluses faces much less immediate pressure to change. Keynes regarded that asymmetry as destabilizing. When one country operates with a trade surplus, another must operate with a trade deficit.

The United States, expecting to remain a major postwar surplus country, opposed this symmetric approach.

Wage Inequality

A worker can perform essentially the same job in two different countries and receive dramatically different wages.

A hotel employee might earn several thousand dollars per month in one country and a few hundred dollars per month in another. A construction worker, teacher, farm worker or nurse may experience similarly large differences.

These wages emerge from the economic system surrounding the worker.

The World Bank estimates that differences in “human capital,” such as health, skills, and experience, account for a substantial share of income disparity between countries. Moreover, workers with access to better infrastructure, machinery, technology, education, electricity, financing and institutional support are arguably empowered to produce more economic value per hour, in the debt-based currency system.

Wages are also influenced by supply and demand, bargaining power, labor laws, access to education and healthcare, capital available per worker, political stability, property ownership and legal institutions — and the country’s position within global production chains.

Let’s explore how this occurs. One important mechanism involves tradable and non-tradable goods.

Imagine two countries.Workers in Country A's export industries are highly productive because they have sophisticated machinery, infrastructure and technology. Workers in Country B have considerably less capital and infrastructure available to them.

Country A's highly productive industries can afford higher wages in order to retain skilled workers — but those higher wages don't remain confined to factories. Restaurants, childcare centers, hairdressers, construction companies and grocery stores must compete for workers too. Moreover, the higher wages of the productive industries empower spillover — or the ability for businesses to charge higher prices.

Their wages therefore rise — even though the technology and skill of cutting someone's hair in Country A isn't necessarily better than that of Country B.This helps explain why both wages and local prices tend to be higher in wealthier economies.

Non-traded goods and services generally cost less in poorer countries and that market exchange rates therefore tend to understate the real purchasing power of incomes in those countries, according to the World Bank. Suppose a worker earns the equivalent of USD 500 per month when her salary is converted into dollars at the market exchange rate.That does not necessarily mean she can purchase only one-tenth of what an American earning USD 5,000 can purchase locally.

Housing, food, transportation and services may be much cheaper in her country.Economists therefore use purchasing power parity, or PPP, when comparing living standards. PPP asks approximately: How much local currency is required to purchase an equivalent basket of goods and services?

Market exchange rates answer a different question: At what rate are currencies actually being exchanged in financial and foreign-exchange markets?

Those numbers can be dramatically different. This is extremely important when discussing poverty. A weak exchange rate does not automatically mean that domestic purchasing power is equally weak.

Why does poverty exist?

PPP adjustment does not make extreme poverty disappear. In some countries, people genuinely have access to far fewer goods, services and productive resources.The underlying causes can accumulate over generations.

A country may have inadequate infrastructure.Its population may have limited access to education, healthcare, sanitation, electricity or finance. Political instability or war may destroy productive capital. Corruption or weak institutions may discourage investment. Colonial extraction may have left highly unequal patterns of land, infrastructure or resource ownership. Heavy external debt can direct government revenues toward creditors rather than domestic investment.

Dependence upon one or two commodity exports can make national income extraordinarily vulnerable to global price movements. Rapid population growth without corresponding capital formation can reduce capital available per worker. Climate and environmental degradation can undermine agriculture, water supplies and human health.

And these problems can reinforce one another. Low productivity produces low incomes. Low incomes produce low savings and tax revenues. Low savings constrain investment.

Weak investment constrains infrastructure and productivity. Weak productivity constrains wages again. Poverty can therefore become systemic.

Weak Currency

A currency's international exchange value is not determined simply by the amount of labor occurring inside the country. It reflects demand for and supply of that currency in foreign-exchange markets.

Suppose a country imports: fuel, medicine, machinery, food, technology, and industrial components. But foreigners purchase relatively few goods from that country.

The country continually needs foreign currency to pay for imports.

If many of those imports are invoiced in dollars, importers continually need dollars. They therefore sell their domestic currency to obtain dollars. Persistent pressure of this kind can weaken the local currency. If the government, banks or corporations have also borrowed heavily in dollars, the problem can compound.

A falling local currency makes each dollar of debt more expensive in domestic-currency terms.That can increase demand for dollars further.

The BIS notes that dollar invoicing and foreign-currency borrowing create precisely these kinds of exchange-rate and balance-sheet vulnerabilities.

Now imagine the country also needs to import oil, which is predominantly sold in USD. Oil becomes more expensive domestically when the local currency falls.Transportation becomes more expensive. Food distribution becomes more expensive. Electricity may become more expensive. Businesses raise prices.

Workers need higher wages simply to maintain their previous standard of living.The currency can come under further pressure.This can become a dangerous feedback loop.

Countries enter international markets with profoundly different productive capacities, resources, institutions, debt burdens and currencies. A country whose currency is widely accepted internationally can borrow and transact internationally in its own currency with much greater ease than a country whose currency is rarely accepted abroad.

Such a country may need to earn or borrow foreign currency before it can purchase critical imports.This creates an important asymmetry.

Some countries can issue liabilities — such as the Eurodollar — in currencies the rest of the world wants to hold. Others must first obtain those currencies through exports, investment or borrowing.

That difference becomes especially important when the internationally demanded currency is the USD.

Petrodollar

Roughly 80 percent of the world’s oil is priced in USD. This accounts for approximately USD 2.5 - USD in oil sales globally. Following the end of USD convertibility into gold in 1971, the dollar’s precipitous fall in value took with it the purchasing power of Middle East oil producers, who already priced their oil in gold. The US first offered Saudi Arabia military protection in exchange for the country’s agreement to continue selling oil in USD — and buy US Treasuries with the proceeds. By 1975, OPEC members agreed to continue pricing their oil in dollars.

Through a process called petrodollar recycling, oil-producing nations use their glut of USD to buy US goods, fund investments at home and abroad, and of course, to buy debt.

Nations who are the subject of US sanctions, or who face difficulty acquiring dollars, are challenged to buy or sell oil. Venezuela recently attempted to sell its oil in a cryptocurrency and failed; following the US seizure of its leader Nicolas Maduro, its oil sales are now managed by the US, with a reported USD 13bn of Iran oil sale proceeds sitting in US accounts. Iran and Russia, meanwhile, are successfully selling oil in Chinese Yuan or Indian Rupees.

The United Arab Emirates recently ended its participation in OPEC, along with oil producing nations Angola and Ecuador. OPEC members agree on oil production targets in order to maximize oil sale revenue.

Oil provides one of the clearest examples of how a commodity can reinforce the international importance of a currency, and measures which may be taken to maintain that importance.

Commodity Currency

Countries heavily dependent upon commodity exports can also develop what economists call commodity currencies.

The Canadian dollar, Australian dollar and some other currencies have historically exhibited relationships with commodity prices because commodities represent important portions of those countries' exports. If foreign demand increases, export prices rise, along with national income and currency.

If commodity prices collapse, the reverse can occur.

SDR

The Special Drawing Right, or SDR, was created by the International Monetary Fund in 1969 as a supplementary international reserve asset when the gold-backed USD was meeting severe limitations to expansion. Its value is determined by weighted a basket consisting of the: USD (43.4%), Euro (29.3%), Chinese Yuan (12.3%), Japanese Yen (7.6%), and British Pound (7.4%). It carries an interest rate of 2.888%, as of August 2026.

Countries and an exclusive group of authorized institutions can hold SDRs and exchange them for freely usable currencies. While individuals and ordinary companies cannot use SDRs as everyday money, the SDRs serve in part as a means to send aid to developing nations in need.

The IMF reports that approximately SDR 660.7bn — about USD 943bn — has been allocated since the system was created. It is used primarily for liquidity, with USD 651bn distributed to IMF member nations in 2021. Distributions are based on quota, with wealthy nations constituting the largest share. The exchange rate between the USD and SDR as of August 2026 was 1.41 SDR to USD and 1.21 SDR to EUR.

It demonstrates that an international reserve asset does not necessarily have to be identical to the domestic currency of a single country. But SDRs have not replaced national currencies as the principal mechanism for global trade, banking or settlement. It currently makes up only 2% - 3% of global foreign reserve assets and is currently not used for global trade or commercial settlement.

FOUNDATIONS

Understanding Debt & Debt-Based Currency

What debt is, how it becomes money, and what the concept of owing means for human health and well-being.

Welcome to the world of debt. Debt-based, or fiat, currency, is currency backed by debt. The money you hold in your bank account is a future obligation to pay a debt, belonging to someone, somewhere in the world. On this page, we focus on the US Dollar, given its predominant status as a global reserve currency.

FOUNDATIONS

Understanding Debt & Debt-Based Currency

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