A. Today it seems natural to exchange goods for pieces of printed paper, but the idea that paper itself could represent value was once revolutionary. The first true paper money was developed in China roughly a thousand years ago, more than six centuries before banknotes became common in Europe. Understanding how this happened requires looking at a series of practical problems faced by merchants and governments.
B. The story begins with a practical problem. In the Tang dynasty, merchants who travelled long distances to buy goods such as tea had to carry heavy strings of copper coins. In the ninth century, a system known as 'flying money' developed: a merchant could deposit coins in the capital and receive a certificate, which he could exchange for coins in a distant province. These certificates were not money in the full sense, because they could not be spent in ordinary shops, but they showed that paper could safely stand for metal.
C. The next step took place in Sichuan, in south-western China. The region used coins made of iron rather than copper, and because iron was worth relatively little, even modest purchases required enormous weights of coins. Around the end of the tenth century, merchants in the provincial capital began issuing paper receipts, called jiaozi, to customers who deposited iron coins with them. The receipts soon circulated as money in their own right. Problems arose, however, when some merchants issued more receipts than they could redeem, and in 1023 the Song government took control of the system, establishing an official office to print notes.
D. Government control brought both advantages and dangers. Official notes were widely trusted, carried security features such as complex designs and several colours of ink, and were valid only for a fixed period, after which they had to be exchanged for new ones. But governments soon discovered that printing money was an easy way to pay for wars and other expenses. When too many notes were printed, their value fell and prices rose, the phenomenon we now call inflation. This pattern was repeated under several dynasties.
E. The Mongol rulers of the Yuan dynasty made paper money the main currency across their empire, and visitors from abroad were astonished. The Venetian traveller Marco Polo, who described China in the late thirteenth century, devoted a chapter to the way the emperor turned the bark of mulberry trees into something as valuable as gold. Yet the Yuan government also printed notes excessively, especially in its final decades, and the resulting collapse in their value contributed to economic disorder.
F. The early Ming dynasty issued its own notes, but it was unable to maintain their value, and by the late fifteenth century paper money had largely fallen out of use in China, replaced by silver. In Europe, the first banknotes issued by a bank appeared in Sweden in 1661. The Chinese experience, however, had already demonstrated both the convenience of paper money and the discipline required to keep it valuable, a lesson that governments around the world continue to learn.