Early History of Paper Money

Jiaozi, or “exchange bills,” generally considered the world’s earliest paper money, originated in Sichuan, China in the mid-990s. Initially issued privately by merchants in exchange for deposits of cash, gold, silver, or silk, jiaozi were subjected to government regulation in 1005 by Zhang Yong, the prefect of Chengdu. The right to issue the notes was restricted to sixteen merchant houses deemed to have sufficient financial resources, and the government imposed no limits on the amount of jiaozi they could issue. The merchant houses invested their cash deposits in real estate, arable lands, and luxury commodities, leaving many of them without the liquidity to redeem the notes they issued. By 1019, jiaozi were being discounted by 20-30 percent and the issue of new bills was halted.
960 Song Dynasty Jiaozi

In 1023, a central Currency Bureau was established with exclusive authority to issue jiaozi. In order to control the amount of paper money in circulation, as well as discourage counterfeiting, the government required that notes be redeemed for new ones every 2 years (at the cost of a 3 percent commission fee), during which time a fixed amount of jiaozi was issued. The currency became highly popular and often traded at a premium over its nominal value.

Following the outbreak of war in the 1040s, however, the government increased the amount of jiaozi it issued to cover military expenditures. By the early 1100s, with defense costs spiraling out of control, the government drastically raised the emission of currency by 20-fold. This increase in the supply of paper money, combined with a growing problem with counterfeiting, incited a steep depreciation of jiaozi, which by 1107 sank to less than 10 percent of their face value.

With jiaozi currency now virtually worthless, the government decided to replace it with a new paper money called qianyin. In an effort to raise the value of paper money by reducing the quantity in circulation, the government exchanged the new qianyin on a 1:4 basis with the old jiaozi. By 1108, though, the qianyin had fallen to a mere 10 percent of their face value.

From the 12th century on, various attempts were made in China to stabilize existing paper currencies and establish new ones: exchange rates were fixed, the use of precious metals for exchange was prohibited, anti-hoarding laws were passed, and even the use of coins was prohibited. All of these monetary policies failed. By 1368 paper currencies became utterly discredited and trade regressed to the level of barter. In this economic climate, precious metals were most treasured of all, and the price of silver reached its highest level in Chinese imperial history.

In the 1430s, the Ming dynasty yielded to economic realities and abandoned its paper currency, surrendering to the dominance of silver in the private economy. Silver prevailed as the monetary standard in China until the 20th century, despite attempts to restore paper currency during times of financial crisis, such as the fall of the Ming dynasty in 1644, the depression of the 1830s and 1840s, and the Taiping Rebellion of the 1850s and 1860s. Not until 1935, under the Republic of China, did the country once again have a fiat money system.

Source:  The Origins of Value: The Financial Innovations that Created Modern Capital Markets edited by William Goetzmann and K. Geert Rouwenhorst [Oxford University Press (August 1, 2005)]

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