The early Chinese first developed paper from the fibrous bark of the mulberry tree. This innovation led to others over the centuries and eventually to the invention of paper money, which revolutionized finance. Merchants found that paper notes of credit enabled them to conduct business over long distances, without relying on bulky coins or barter goods. By the Song Dynasty, the Chinese government was making official paper currency.

A Tradition of Trade

Chinese merchants pioneered the Silk Road to trade silk and other commodities with central Asia and the Mideast as early as around 500 B.C. The vast size of China, even in early times, and the sophistication of its trading culture meant that Chinese merchants could expect to do business with customers and suppliers spread out over thousands of miles. The use of heavy coins added to the logistical problems of transporting trade goods and exacerbated the risks posed by robbers along the way.

Bearer Notes and Flying Money

The Tang Dynasty, which began in 618 A.D., saw an increased need for minted metal coins. Merchants circumvented the demand for bulky coins by writing notes of credit. Such notes were not paper currency, but they show how smoothly the transition from copper to paper could be once people accepted the basic idea that the paper represented value. By the end of the Tang Dynasty in 907, traders had begun depositing valuables with trade corporations and carrying bearer notes instead of the valuables themselves. Official government treasuries encouraged merchants to deposit coins in exchange for notes nicknamed “flying money.”

Government Bank Notes

While “flying money” served as the origin for paper currency, actual currency had to wait just over a century. In the 11th century, in the Song Dynasty, merchants ran into another problem with coins – a shortage of copper in Szechuan Province. Paper bank notes began to replace coins. Although these were privately issued drafts, they are considered the first paper currency, because they were accepted as representing a monetary reserve. At first, this reserve was coins and salt, but later the notes represented silver and gold. The Chinese government eventually took on the monopoly for issuing such notes, and during the Yuan Dynasty, which began in 1279, paper became the only official currency in China.

Marco Polo’s Discovery

It was during the Yuan Dynasty that European explorer and trader Marco Polo first encountered paper money. His account of the efficiency and power of the notes influenced European economic thought. He marveled at the readiness with which merchants throughout Kublai Khan’s large realm accepted “these pieces of paper,” suggesting that paper currency had become general in China by the time of Polo’s visit in the 13th century. Polo also describes the Chinese government’s policy of buying up individuals’ gold, silver and other valuables to maintain its monopoly; the fair price paid by magistrates for the gems and precious metals ensured the system’s survival.