The Origins of Paper Money

A For most of human history, money meant metal. Coins of gold, silver, bronze and copper were carried, weighed and counted in every marketplace from China to the Mediterranean, and their value lay in the precious material from which they were struck. Metal coins had obvious advantages: they were durable, hard to fake and accepted almost everywhere. Yet they also had a serious drawback that grew more troublesome as trade expanded. A large sum of money in coin was extremely heavy, and a merchant wishing to buy goods in a distant city faced the daunting prospect of transporting a great weight of metal over long and often dangerous roads. As commerce reached across ever greater distances, the sheer bulk of coinage became a genuine obstacle to doing business. A trader who wished to settle a large account might need a cart and a guard simply to move the necessary metal, and the cost and risk of transporting so much wealth ate into the profits of long-distance trade.

B The first solution to this problem appeared in China, many centuries before anything similar was seen elsewhere. Merchants who did not wish to carry heavy strings of coins began to deposit them with trusted deposit shops, receiving in return a written note that recorded the amount left behind. The note could later be presented, at the same shop or an associated one, and exchanged once more for coin. These paper receipts were far lighter and safer to carry than the coins themselves, and before long the notes began to circulate from hand to hand as if they were money, since everyone understood that they could be redeemed for metal whenever required.

C What had begun as a private convenience among merchants eventually attracted the attention of the state. Recognising both the usefulness of paper notes and the profit to be made from issuing them, the government took over their production, printing official notes backed by its own authority. This was a momentous step, for it meant that pieces of paper, worth nothing in themselves, could serve as money simply because the authorities declared that they did and the public agreed to accept them. For the first time in history, the value of money rested not on the metal it contained but on trust and official promise.

D The strangeness of this arrangement was captured vividly by a foreign visitor. The Italian traveller Marco Polo, who journeyed through China in the thirteenth century, devoted a famous passage of his account to the paper money he saw in use there. He marvelled that the ruler could take the bark of trees, turn it into paper, stamp it with an official seal, and thereby create something that all his subjects would accept in payment as readily as if it were gold. To European readers of the time, accustomed only to coins of precious metal, the idea seemed scarcely believable, and some doubted whether his report could possibly be true.

E Yet the history of paper money also revealed its dangers. Because notes were so cheap and easy to produce, there was a constant temptation for governments in financial difficulty to print more of them than the economy could support. When too many notes were issued, each one bought less than before, and prices rose steadily in what we would now call inflation. On several occasions the value of the paper collapsed, public confidence evaporated, and people refused to accept the notes at all, forcing a return to coin. The very feature that made paper money so convenient, the ease with which it could be created, was also the source of its greatest weakness.

F Paper money took a remarkably long time to establish itself in the West. It was not until the seventeenth century that European banknotes appeared in a recognisable form, issued first by private goldsmiths who held their customers' gold for safekeeping and gave out receipts that could be passed from person to person. From these modest beginnings grew the banknotes and the banking systems that would eventually spread across the world. The long delay is striking, for the essential idea had been worked out in China hundreds of years earlier, a reminder that useful inventions do not always travel quickly, and that the same discovery may be made, and made to matter, at very different times in different places.