Metal that's awkward to pay with
In China's Sichuan province at the turn of the 10th and 11th centuries, iron coins circulated: copper was scarce in the region, while iron was plentiful. Iron is cheap, so a purchase required lots of coins, making a bundle so heavy that it was easier to haul it on a cart. A major transaction became a small move.
Merchants and money-changing shops found a solution. You deposit your coins for safekeeping and receive a paper receipt: this much metal is stored in this place. The receipt is easy to fold and pass to someone else - and it turned out they were willing to accept it too, because they trusted that the metal was there. So receipts began changing hands instead of coins, while the coins stayed put.
In 1023, the state took over the issuance of these receipts in Sichuan: private shops went bust, and exchange stopped working. Historians debate from what point these papers should be called money rather than storage receipts - the line is blurry. But the basic structure was already there.
Deposit your metal. The coins go into storage and stay where they are.
Get a receipt. A sheet of paper stating how much metal stands behind it.
Pay with the receipt. The seller accepts it because she is sure the metal can be collected any day.
The receipt moves on. It passes from hand to hand, while almost no one comes for the metal.
Why receipts outnumber the metal
The person storing the metal quickly notices that all receipt holders never come at once. So they can issue more paper than is in the basement, and for a while nothing happens. This isn't malicious intent, but a feature of the system: a promise is easy to repeat, while metal isn't.
China went all the way down this path. Under the Mongol dynasty, paper money circulated throughout the country; the next dynasty tried again and printed too much once more. By the mid-15th century, paper had almost left circulation, and payments returned to silver. In Europe, the first banknotes were issued by Stockholm Bank in 1661 - for the same reason: local copper payment plates were impossibly heavy, with the largest weighing about 20 kilograms. A few years later, the bank also issued too much, and had to close.
On the left, there are roughly as many receipts as there is metal. The marker shows where noticeably more paper has been issued than the reserve.
The piece of paper itself doesn't change. One number changes, and it isn't written on it: how many identical papers have been issued beyond the reserve.
That's why the story of paper money isn't a story of invention, but a story of trust. A receipt works only until everyone starts checking it at once.
Paper money appeared where metal was hard to carry, and stayed where a promise proved more convenient than the thing itself.
Why did people start paying with receipts instead of heavy coins?
What can happen if more receipts are issued than the metal reserve?
Sources
- Richard von Glahn, "The Economic History of China" (2016)
- Bank of Sweden materials on Stockholm Bank's 1661 banknotes
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