Trading paper for gold
It was the Chinese who first came up with paper money. They used bark, stamped with imperial symbols as a form of currency. The consequence of forging one of these stamps was dire; anyone caught doing so was immediately put to death.
During the 1100’s, Europe saw currency made from leather for a short time, but it soon fell out of favour. The problem was that it was hard to keep a consistent value on it, and people were generally untrusting of it. They had a hard time believing that if they handed a cow over for a few pieces of painted leather, they would be able to later spend that leather on something they needed.
It was the goldsmiths that actually came up with a useful system of paper money in Europe, but it didn’t happen until the 1700’s.
For years, goldsmiths had been handing out receipts to people when they brought in their gold to be cleaned and melted down. These receipts represented an actual amount of gold sitting in the goldsmith’s own shop.
Customers who had these receipts gradually began trading them for goods and services. The receipts had value because anyone could take a receipt down to the goldsmith and retrieve the actual amount of gold listed on the receipt.
This is where the term “backed by gold” came, and it wasn’t long before the governments caught on to the idea. The idea that a currency could represent an actual amount of gold somewhere was the driving force of the world’s economies until 1971, and it was known as The Gold Standard.