Paper Money

Paper money is an instrument of abstraction. Where a gold coin presents its value tangibly -- as weight, purity, and metallurgical fact -- a paper note presents only a promise. It is a document recording a claim, enforceable by whoever stands behind it. The history of paper money is largely the history of establishing and then repeatedly testing that enforceability: who makes the promise, who guarantees it, and what happens when they cannot or will not.

The first sustained experiments with paper money occurred in China during the Tang dynasty (618-907 CE) and were systematized under the Song (960-1279 CE). The original instruments were "flying money" -- receipts issued by provincial governments to merchants, allowing them to deposit heavy copper coins in one city and claim equivalent value in another. The Song government later issued true government-backed paper currency, the jiaozi, which circulated alongside metal coins. As with nearly every paper money experiment that followed, overissuance eventually produced inflation, and the currency was periodically restricted or recalled (Von Glahn, 1996).

European paper money emerged much later, through a different institutional path. The goldsmiths of seventeenth-century London discovered that depositors rarely withdrew their gold simultaneously; they could therefore issue more receipts than they held in gold without triggering a crisis, earning interest on the excess. This fractional reserve banking was the technical foundation of the Bank of England (1694), which was chartered specifically to finance government debt in return for the privilege of note issuance. English paper money was, from its inception, a mechanism for funding state expenditure -- a partnership between sovereign need and private profit.

Paper money is a promise. What distinguishes the promise of a central bank from that of a forger is not the paper or the ink -- it is the institutional architecture of enforcement that stands behind it.Adapted from Felix Martin, Money: The Unauthorised Biography (2013)

The United States' experience with paper money was tortured throughout the nineteenth century. The Continental Congress issued paper currency to finance the Revolution; rapid depreciation gave rise to the phrase "not worth a Continental." The Civil War produced greenbacks -- legal tender notes not backed by gold -- that circulated at a discount to gold-backed currency and generated ferocious political controversy about their legitimacy. After the war, deflationists (creditors and bankers) pushed for return to the gold standard; inflationists (farmers and debtors) fought for continued paper circulation or silver coinage (Friedman and Schwartz, 1963).

The Federal Reserve's notes today carry no commodity backing whatsoever. They are legal tender by statute, valuable because the government demands them in tax payment and courts enforce contracts denominated in them. This is not a departure from money's historical logic -- it is its fulfillment: money was always primarily a social and institutional construct, and the removal of the gold fiction merely made that visible.