Paper Money Definition
Paper money is a country’s currency in the form of bank notes which have a specific value and are used to pay for goods and services. Paper money holds the backing of a country’s government while the central bank keeps a controls over the note’s printing and circulation.
- Paper money or a banknoteBanknoteA banknote refers to a country’s currency in the form of paper. is a form of currency that bears different denominations in most cases and is used as an authorized medium to make payments for goods and services. The denominations represent the value of the notes.
- They have been around since 1000 AD when China started issuing them due to the inconvenient weight of the coins.
- Though initially backed by precious metals, most paper money today is fiat money. The government backs fiat moneyFiat MoneyFiat money is a currency that is declared by the government to be legal tender and has no physical backing such as gold; rather, the value of fiat money is derived from the market's demand-supply relationship. India's and America's fiat currencies are the India Rupee and the US Dollar, respectively.. Fiat money does not hold any intrinsic value and is instead valued based on the stability of the government.
Understanding Paper Money
Paper money represents a certain face value printed on the paper. It acts as a medium of exchange for trading, gifting and welfare purpose. Let us take you through the evolution of money to understand paper money better.
- Millenniums ago, people participated in the barter system of exchange to acquire any commodity they were in need of. People exchanged a commodity in exchange for another. The objects of exchange were anything from weapons, metals, fabric, animal skin, to food products.
- This was inefficient due to the difficulty in equating the value of one item with another. For example, knowing the worth of wooden logs is difficult when one wants to barter it with an exact value of corn or rice.
- Gradually, some societies started using gold and silver as a medium of exchange as they were precious metals with huge demand. The Lydian Kings are said to be the inventor of money as they produced the first coins around 600 BC.
- Coins made of metal such as gold, silver and copper prospered as a medium of exchange in different societies. It started creating a shortage of metals in addition to weighing down the carriers with their weight.
- A promissory notePromissory NoteA promissory note is defined as a debt instrument in which the issuer of the note promises to pay a specified amount to a party on a particular date. started appearing as a solution to this problem. The first paper money was issued in China under the Song Dynasty (AD 960–1279). The notes were backed by silver or gold. Paper notes surfaced in Europe after over 500 years when the legendary explorer Marco Polo mentioned about their existence in China.
- Till 1971, the paper notes continued to work as commodity money backed with the values of gold or silver. In the 19th Century, paper money as we know it today emerged, which was a fiat currency or a banknote. Examples include a dollar, euro, or peso etc.
- Most of the paper money today is fiat money. Fiat money is backed by the government of a country and is considered to be a legal tender. The value of commodity money equated to the weight of the substance it was made from. Fiat money does not hold any such intrinsic valueIntrinsic ValueIntrinsic value is defined as the net present value of all future free cash flows to equity (FCFE) generated by a company over the course of its existence. It reflects the true value of the company that underlies the stock, i.e. the amount of money that might be received if the company and all of its assets were sold today..
- The value of fiat money is based on the stability of the government that has issued it. For the countries under recession or facing political crisis, the value of their currency falls sharply, reducing the value of their fiat money.
- Fiat money allows the printing control to lie with a country’s central bank. It gives the bank an avenue to issue more notes in shortage. It often poses the threat of printing an undue amount of notes which could lead to inflation.
- Paper money in countries such as India, China, Mexico and the like endure the brunt of counterfeit. As such, governments worldwide keep coming with different methodologies to overcome this issue to strengthen their currency’s security. Becoming cashless with digital payments and cryptocurrency was one such move, in addition to enhancing the convenience.
Paper Money in the US
With the Mint Act of 1792, the US dollar or simply dollar became the United States of America’s official currency. In 1793, the first U.S. coins came into being. In 1861, due to the Civil War, the government issued and circulated its first paper money, referred to as greenbacks. Greenbacks were demand notes, and they were an attempt to finance the war. Greenbacks were retired in 1862. In their place were issued United States notes, also called legal tender notes.
It was not until 1913 that the government passed the Federal Reserve Act, which led to establishing the US Federal Reserve System. The act gave the Federal Reserve Banks the authority to issue the still in function – Federal Reserve Banknotes.
Gradually, the dollar became fiat money after 1970. The banknotes in the US are made from cotton fiber, giving them a unique texture to prevent counterfeit. The US dollar is a global reserve currency and is used by many other countries as their currency. Dollar comes in denominations of $1, $2, $5, $10, $20, $50 and $100.
The US dollar is one of the most powerful currencies in the world. One crucial reason that most currencies are usually measured against the dollar is that the dollar had emerged as economically strong after the World Wars. Besides, since it is a fiat currency, the US’s prosperity and internal stability have often ensured that it remains strong.
Paper Money in China
After dealing with commodity money for a long time, the people in China started to get tired from the weight of carrying metal coins around. Moreover, there started to be a shortage of certain metals. In the Tang Dynasty (618–907 CE) reign, many merchants started to keep their coins in a trustworthy agent’s custody.
In return, the agent recorded the number of coins submitted on a piece of paper which acted as a promissory note. The note could be used in trades and exchanged in return for coins from the agent.
Later on, the Song Dynasty saw the most earlier known appearances of paper notes backed by an authority. The dynasty issued paper money that had the backing of its administration and was named jiaozi. As the Chinese interacted with other cultures along the silk trail, other kingdoms and dynasties noticed the benefits of jiaozi and started adopting their own kind. With the changes in the dynasties, the money kept changing.
In December 1948, China saw its first renminbi (RMB), which translates to “people’s currency.” It was issued with the foundation of the People’s Bank of China (PBOC). After the Civil War, the People’s Republic of China came into being, and the yuan earned itself the badge of being the only unified legal currency. Yuan comes in many denominations like the US denominations. The paper is made of the wood fiber.
The government launched several RMB series over the years. Recently, China was in the news for testing out its own digital currency, Digital Yuan, which puts it in the race to develop the world’s first sovereign digital currency.
This has been a guide to what is Paper Money and its definition. Here we discuss examples of how paper money is used in the US and China. You can learn more from the following articles –