Paper Money, from Song China to Europe

A coin carries its value, or at least a claim to it, in its metal. A banknote carries almost nothing: a few grams of paper, some ink and a promise. That a whole society should accept such a thing in payment is one of the more remarkable facts of economic history. It happened first in China, and it happened because of a practical problem with iron.

Flying money and heavy coins

Under the Tang dynasty, in the ninth century, merchants who sold goods in distant provinces faced the risk and expense of carrying strings of copper coins home. A system grew up in which a merchant could deposit coins with an official agency or a provincial office in the capital and receive a certificate, which could be redeemed for coins in another region. Contemporaries called these certificates feiqian, flying money, because the value seemed to travel without the coins. They were remittance orders rather than currency, but they accustomed people to the idea that a paper could stand for metal.

The decisive step came in the province of Sichuan in the early Song period. Sichuan used iron coins, which were worth far less for their weight than copper. A modest purchase required a burdensome load of metal. Merchants in Chengdu began to issue deposit receipts that could circulate in place of the coins, and a group of wealthy houses was given the right to issue them under official supervision.

The state takes over: jiaozi and huizi

Private issuance did not last. When some issuers failed to redeem their receipts, the government stepped in. In 1023 the Song established an official bureau in Sichuan, and in 1024 it issued the first government paper currency, known as jiaozi. The notes were printed in a fixed series, were valid for a set term, and were supposed to be backed by a reserve of coin.

For a time the system worked well. But paper money is cheaper to produce than coin, and a government at war always needs more of it. Under the Southern Song, a new note called the huizi was introduced in 1160. As the state fought first the Jurchen Jin and then the Mongols, it issued notes in ever greater quantities, and they lost much of their value. The historian Richard von Glahn has traced this cycle in detail: initial success, growing fiscal pressure, over-issue, loss of confidence.

Printing against forgery

A note that anyone could copy would be worthless, so Chinese issuers went to great lengths to make their paper hard to imitate. Notes were printed from carved blocks or metal plates, often in more than one colour, on special paper, and stamped with official seals. They carried serial numbers and the signatures or marks of the officials responsible. Many later notes also carried printed warnings: the text of Ming notes, for instance, announced that counterfeiters would be put to death and that anyone who reported them would be given a reward in silver together with the counterfeiter’s property.

The effort shows that the issuers understood the core problem of paper money very clearly. A coin’s metal offered some protection against forgery, since a fake had to contain metal of its own. A note had nothing but its design. Every security feature on a modern banknote, from watermarks to holograms, is a continuation of the same contest between issuers and forgers that began in Sichuan a thousand years ago.

Marco Polo and the Great Khan’s paper

The Mongol Yuan dynasty, which conquered the Song, made paper money the main currency of the empire. In 1260 Kublai Khan’s government issued a new note, the Zhongtong chao, and the use of coin was restricted in favour of paper.

Europeans learned of this through the account dictated by the Venetian Marco Polo around 1300. Polo described how the inner bark of the mulberry tree was made into sheets, cut to different sizes, and stamped with the Great Khan’s seal, and how everyone throughout the empire was obliged to accept it. He plainly found it astonishing that the ruler could, in effect, turn tree bark into currency. European readers found it hard to believe.

The Yuan, too, issued more than the system could bear, especially in its final decades. The Ming dynasty, which replaced it, issued its own notes, the Da Ming Baochao, from 1375. These were not convertible into metal, and they steadily lost value. Over the following century, uncoined silver weighed by the ounce became the medium of large transactions in practice, and paper money faded from Chinese economic life for a long time.

Europe’s slower path

Europe arrived at the banknote by a different route, through merchants’ paper rather than state decree. Italian merchants of the thirteenth and fourteenth centuries used bills of exchange: written orders to pay a sum in another city, often in another currency. In seventeenth-century London, goldsmiths who kept customers’ coin in their vaults issued receipts that could be passed from hand to hand. These were private promises, valued according to the reputation of whoever had signed them.

Stockholm, 1661

The first true European banknotes were issued in Sweden. Sweden’s money at the time included large copper plates, some weighing many kilograms, which were inconvenient in the extreme. In 1661 Stockholms Banco, a bank founded by Johan Palmstruch, began issuing credit notes that could be used in place of the plates. They were popular until the bank issued more than it could redeem. It failed, Palmstruch was prosecuted, and in 1668 the Swedish parliament established a new bank under its own control, the forerunner of the Riksbank, today the oldest central bank still operating.

London and Massachusetts

The Bank of England was founded in 1694 to lend to the government during war with France, and it issued notes against its deposits. A few years earlier, in 1690, the Massachusetts Bay Colony had issued paper bills of credit to pay soldiers coming home from a failed expedition against Quebec, among the first government-issued paper currencies in the Western world. Other American colonies followed. In 1729 the young printer Benjamin Franklin published a pamphlet, A Modest Enquiry into the Nature and Necessity of a Paper-Currency, arguing that a well-managed paper money could serve a growing economy. He later printed notes for several colonies.

John Law’s experiment

The most dramatic early European experiment was French. The Scottish financier John Law persuaded the regent of France to let him open a bank in 1716, the Banque Générale, which issued notes. It became the royal bank in 1718 and was tied to a trading company with rights over French Louisiana. For a short time the scheme seemed to work brilliantly. Then confidence broke, and by 1720 the system had collapsed, Law had fled the country, and the French public had learned a deep distrust of paper money and of banks that would last for generations.

Seventy years later, revolutionary France tried again with the assignats, notes notionally backed by confiscated church land. They, too, were issued in quantities that destroyed their value within a few years.

The lesson of the note

Read together, these episodes tell a consistent story. Paper money is an extraordinary convenience. It is light, divisible and cheap to produce. But that last property is also its weakness. Because issuing more costs almost nothing, the value of paper money depends on the willingness of the issuer to limit how much it creates, and on the public’s belief in that willingness.

Different societies tried different ways of building that belief. Some promised convertibility into metal. Some gave the right of issue to banks with independent governance. In the nineteenth century, many tied their currencies firmly to gold, a story we follow in a later essay.

The same question sat at the heart of the digital cash projects of the late twentieth century, and of the Bitcoin design of 2008, whose issuance follows a schedule written into its rules rather than the decision of any authority. Whether one finds that design attractive or not, it is clearly an answer to a very old problem: how to keep the power to create money from being abused by whoever holds it.