Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche


A Brief History of Fiat Currency

Fiat currency was one of the most revolutionary inventions in history, yet few of us know its history.

A fiat currency is money created by government order or fiat. In the modern world, a fiat currency, such as the US dollar, is a nation’s official currency or legal tender. Generally, central banks, such as the US Federal Reserve, issue fiat currencies.

All the world’s economies run on fiat currencies. Fiat currencies enable you to walk into any store and pay for your stuff.

International trade and finance rely upon reserve currencies. A reserve currency is a fiat currency financial institutions use for international transactions. For example, an American company can use the US dollar (a reserve currency) to buy oil in Saudi Arabia or manufactured goods in China.

Hence, fiat currencies are one of the most important inventions in human history. Yet few of us know where fiat currencies come from or how they work.

The Origin of Fiat Currency

China’s Song Dynasty issued the first known fiat currency in the 12th century AD.

The Song nationalized a system of private promissory notes, or letters of credit merchants, had been using for centuries. Under the Song, the imperial government began printing a paper currency known as the jiaozi. The jiaozi was a fiat currency because people used it for transactions.

Similarly to modern cryptocurrencies, the jiaozi was first produced by private merchants. Eventually, the government began printing and issuing jiaozi and making efforts to control and regulate the money supply.

The Jiaozi was the first currency built around the legal fiction of a gold or silver standard. Theoretically, citizens could redeem their jiaozis for metal coins. However, most people were too lazy to cash in the paper.

Unlike modern banknotes, jiaozi could expire. When Kublai Khan’s Mongol Yuan Dynasty replaced the Song. The jiaozi became the chao. One admirer of the chao was legendary travel writer Marco Polo, who popularized the idea of paper money in Europe.

The Chao became the first fiat currency destroyed by inflation because gold or silver did not back it. Paper money production in China continued until 1450, when the Ming Dynasty ended the practice. The Ming replaced the Chao with silver coins.

Interestingly, the paper currency disappeared from China for over 400 years. The last Ming Emperor tried reviving paper money in the 17th century but failed to save his dynasty. The Manchu Qing Dynasty did not start printing paper money again until the 1890s.


Although paper money vanished from China, it soon reappeared in Europe. Stockholm’s Banco began issuing deposit certificates or banknotes in 1661.

Banco founder Johan Palmstruch created the banknotes to prevent a bank run. In 1660, the Swedish government began minting new lighter coins. Many Swedes refused to accept the new coins and began withdrawing the old coins from the bank.

To avoid running out of coins, Palmstruch began issuing deposit certificates, or credit notes, people could redeem for the old coins. The credit notes were a fiat currency because the Swedish public had faith in them.

Over time, the credit notes, which were lighter and easier to carry, became more popular than heavy copper coins. They withdrew the credit notes in 1664 after inflation, and the government imprisoned Palmstruch for fraud.

During the 18th and 19th centuries, many banks imitated Palmstruch by printing banknotes. Both private and central banks printed notes, but notes from central banks were more trusted. Banknotes became more elaborate as counterfeiting became widespread.

Banknotes became an important part of the economy as businesspeople and bankers used them for a wide variety of transactions. They used banknotes because there was no electronic banking and no other good way of moving large amounts of money around.

Central banks issued the largest banknotes for transactions with other central banks. During the late 1940s, the Bank of England had nine £1 million pound notes printed to distribute Marshall Plan aid money. In the 1930s, the 12 US Federal Reserve Banks used $100,000 banknotes to move money between each other.

The Origins of the Pound Sterling 

The most successful fiat currency, the Pound Sterling, began on 27 July 1694 when King William and Queen Mary gave the Bank of England a Royal Charter. As His Majesty’s banker, the Bank of England had the power to loan the government money, issue government debt, and issue banknotes backed by the crown. Those banknotes became the Pound Sterling, the first true global reserve currency.

The Bank of England began issuing printed banknotes in 1725. Originally, the gold backed the banknotes. However, in 1797, Prime Minister William Pitt the Younger transformed the Pound Sterling into a fiat currency by issuing a Privy Council Order that stopped the Bank of England from redeeming banknotes for gold. Pitt was trying to stop a bank run during a war with France.

Pitt’s action transformed the Pound into a fiat currency backed by government debt. People still accepted the pounds despite Pitt’s action. Although they lifted the gold restriction in 1821, faith in the pound was so high almost nobody redeemed them for gold.

Ironically, the pound only became the British Empire’s official currency with the Bank Charter Act of 1844. By then, banks around the world accepted the pound as a reserve currency. Consequently, the City of London the around Threadneedle Street, the Bank of England’s location, became the world’s financial center.

The Origins of the US Dollar

Widespread use of paper money by the public began in Europe and America in the 18th century because of coin shortages.

Paper money has a long history in the USA. The Massachusetts Bay Colony began issuing paper money on 3 February 1690. The colonial government used the banknotes to pay soldiers fighting in King William’s War against the French. During the next seven decades, several colonial governments issued banknotes because of shortages of metal coinage.

In 1775, the Continental Congress began issuing paper money to pay the soldiers fighting in the American Revolution. The idea was to encourage soldiers to fight by paying them in currency they could only redeem for gold or silver – if the Americans won the war.

The Continental Congress got into trouble when America won the war but had no gold or silver to pay angry veterans. Anger at the worthless paper currency discredited the Continental Congress leading to the Constitutional Convention and a new Federal government.

The dollar and the dollar sign originated in the 18th century. In 1785, the dollar sign, an adaptation of the letters US and the Spanish Peso symbol first appeared on US banknotes. In 1792, Congress created the first federal coins and a mint to make them through the Mint Act. The Mint Act mandated decimal currency in the United States and empowered the US Treasury to mint coins.

Rise of the US Dollar

Tellingly, the federal government did not begin issuing paper money again until 1861. That was when the US Treasury began issuing greenbacks, or paper dollars, to pay the Union Army in the Civil War. After the Civil War, the National Banks Act gave “national banks” the right to issue paper notes backed by government bonds.

Centralized printing of banknotes by the Bureau of Engraving began in 1869. In 1877, Congress made the US Department of the Treasury the only official printer of notes, bonds, and securities. During the late 19th century, the Treasury Department issued silver certificates. Banknotes redeemable in silver currency.

The Federal Reserve Act of 1914 replaced the National Banks with 12 Federal Reserve Banks that had the right to issue fiat currency. In 1914, the Federal Reserve issued America’s national banknote a $10 bill. Theoretically, citizens could redeem the Federal Reserve Banknotes for gold or silver coins minted by the US treasury. Interestingly, Congress did not prohibit the redemption of US currency for gold until 1963.

The Federal Reserve and the Treasury stopped printing large denomination banknotes $500, $1,000, $5,000, and $10,000 bills in 1945. However, such bills remained legal tender until 1969, when the Federal Reserve discontinued their use.

The US Dollar became the world’s reserve currency after the collapse of the British Empire in the 1940s. The British Pound Sterling, issued by the Bank of England, became the world’s first true reserve currency in the 19th century.

Although some observers, including financier Ray Dalio, consider the Dutch guilder issued by the Bank of Amsterdam in the 17th and 18th centuries a reserve currency. I don’t consider the guilder a true reserve currency because the Netherlands was not a great military power. Yet they used the guilder worldwide until the 1770s.

The Next Evolution of Fiat Currency

The next evolution of fiat currencies is probably digital or central bank cryptocurrencies. Several central banks, including the Federal Reserve, the People’s Bank of China, and the Bank of England, are researching or experimenting with central bank cryptocurrencies or central bank digital currencies.

The next evolution of fiat currencies is probably digital or central bank cryptocurrencies. Several central banks, including the Federal Reserve, the People’s Bank of China, and the Bank of England, are researching or experimenting with central bank cryptocurrencies or central bank digital currencies.

I predict the next evolution of digital currency will be a central bank stablecoin that makes payment in fiat currency from a central bank. For example, a Fed Coin that makes payment in US dollars from the Federal Reserve when you spend it.

Fiat currency is here to stay even if paper currency disappears. I predict central bank digital currencies will replace cryptocurrencies such as Bitcoin (BTC) just as fiat currency replaced private banknotes.