Just as the Roman Empire was rising to its greatest extent, a clever fellow in China made an interesting discovery. Cai Lun lived in during the latter part of the 1st century CE and into the first part of the 2nd. He was a eunuch court official of the Eastern Han dynasty. He didn't actually invent the idea of making a writing substrate by using plant fibers beaten to a pulp and dried in thin sheets, but his experiments hit upon a novel set of ingredients that produced a product that was dramatically better than anything that had been tried before. It's use for writing quickly spread throughout the Han empire. It would be several hundred years before it would be adapted for monetary transaction needs, but it was good enough that it could be used for that purpose when the time came.
The city of Hangzhou, the capital of the Song dynasty in the 9th century, had grown to a population estimated to be around a million people - similar to what Rome had been six centuries earlier. But, the Chinese had paper, and soon the merchants of Hangzhou came up with a way of using it as legal tender. This solution would last for a couple centuries before it too would fall out of favor, but it did work for long enough for word of what they had done to spread back to the middle east. And thanks to the Battle of Talas River in the year 751, the secret of papermaking made its way to the west as well. And while the westerners did not attempt to use paper for money in the same way the Chinese had done, they did use it for something else that had the same effect. It was called the bill of exchange.
Paper had been developed by a court official named Cai Lun sometime in the first century of the current era. There are accounts of localized used of paper notes as money in the 7th century, but the first usage for which we have solid evidence was in the 10th century. As has always been the case with hard currencies or crow bait, there has never been enough of it to support the needs people have for standardized tokens or something similar to use in transactions instead of struggling with the burdens of the barter system.
Hard currencies sort of worked because they were scarce. It was relatively easy to prevent counterfeiting and the scarcity propped up their assigned value. But there was never enough to displace even 1% of the transactions going on in a barter system. Something better was needed.
Thus it was that in order to support their needs to simply do business in an orderly way, merchants during the Song Dynasty would hit upon the notion of using printed bits of paper to expand the money supply for their markets. Essentially, they once again did the same thing that the ancient Sumerians had done. Their aim was to dramatically expand their markets to include almost everyone. This Jaoizi currency wouldn't change the world everywhere right away, but the seed was planted. The big problem with paper currency, which would not be solved until the 17th century in Sweden, is that it was just too easy to counterfeit. With hard currencies there was never enough, but it could be tied to valuations that could be trusted. But paper currencies were not created in the same way those clay tokens in ancient Sumer were. There was not a one to one relationship between the creation and issuance of the paper money notes and the goods people would show up with at some designated spot on market day. Also, they were issued directly to merchants, and not available to everyone in a direct manner. The general public was multiple transactions removed from the creation and initial distribution process. So of course, the public took matters into their own hands. The counterfeiting of money was born, and thus quickly put an end to the whole experiment. But, it lasted a few decades and people wrote about it, including one name Marco Polo.
Scholars are still debating whether or not Maro Polo actually travelled to China as he claimed in his writings, or merely ventured far enough out on the Silk Road to gather the myths and stories he wrote about. But, his tale of the Chinese using paper that could blow in the wind (hence its nickname "flying money") was based on something that was very real, even though it was winking out of existence right about the time of his travels., and would not be resurrected for nearly a century. Also, it is clear that the Chinese under the Song and later under the Ming dynasties did not understand the need to manage the supply of money relative to the need for it to support transactions. Thus, they repeatedly had massive inflation problems due to the over production of money.
The whole topic of money supply and the degree to which a society has moved from a barter economy to one that uses money will be dealt with extensively in another section of this essay. But one thing worth noting here, is that under the Song dynasty, a serious movement toward the notion of completely displacing the barter economy with a monetized one, especially in their capital city of Hangzhou. It would not spread far, and it would not last, but it did foreshadow things to come centuries later.
The art of papermaking had leaked out of China and into the hands of the Persians as a result of the defeat of the Tang army by the combined armies of the Abbasid Caliphate and their allies the Tibetan Empire at the Battle of Talas River in July of 751ce.
Arguably, that one battle was the single most impactful thing to happen between the fall of the Western Roman Empire in the 5th century and Thomas Newcomen's steam engine of 1712ce.
Papermaking was slow to make its way through the Islamic world to Spain and from there into the rest of Europe. As it had been in China when it was first invented by Cai Lun five centuries before, it was treated as a state secret by the Persians. But by the dawn of the 11th century, the art was beginning to spread across Europe. It really took off when the University of Bologna was founded in 1088 and several printers began producing copies of the writings of the Greek and Romans that had survived in Moorish Spain. Another survivor was the Digest of the Code of Justinian, a copy of which had been found and studied by the Italian jurist Irnerius, which was perhaps the same copy that was identified some years later in the town of Amalfi, just south of Naples, or not. Perhaps there was another copy that has since been lost. Whatever, business was booming in Spain in the 11th century and the needed a corpus of business law and lawyers to go with it, so off they went to Bologna, which in turn drove a big uptick in the demand for books and the paper to make them.
Paper put an end to the dependency on using the hides of lambs and calves to make parchment as the primary material for writing, which it had been for the previous 500 years in Europe. The end of scarcity made the mass production of books possible, and thus learning took off once again. So when Marco Polo's book reported that the Chinese had used it for money, it got people to thinking about the possibilities. While no one was ready to trust bits of paper as a replacement for hard currency right away, there were some related uses to which merchants could put the stuff.
It is worth repeating that commerce and international trade in the medieval period and into the Renaissance did not yet involve ordinary people. But, there was a very active trade in luxury goods from one region to another. Spices, fine wool and linen, and all sorts of things that princes and wealthy merchants might want were being carried on trade routes over land and by merchant vessels following all of the known coastal areas. Almost every region had something that was desired by wealthy people elsewhere. And the reality was still that even though only the wealthy were involved, there wasn't even half enough hard currency in existence as what was needed to support all of the transactions involved. So the Italians invented an early form of international banking.
The bank founded by Giovani di Bicci de' Medici was not the first, nor even the largest bank that thrived in the business of facilitating the movement of trade goods for the wealthy, but it did become the most well known and copied. As a result, it became a vehicle for spreading the knowledge of both double entry bookkeeping, and a document that was the forerunner of modern paper currency, stocks, bonds, and other negotiable instruments. The key was something called a bill of exchange.
Moving hard currency to wherever a transaction was going to take place was impractical at best, and when possible, often too dangerous to attempt. Robbery was common, and there simply wasn't enough of it to be every place that it was needed, even if it wasn't bulky, heavy, and subject to theft.
So the Italian money changers or bankers would send an agent or factor to some distant city with some initial capital or hard currency. They would buy something that was marketable back in Italy, and ship it home along with a document specifying what it was and how much it cost in the local currency.
On arrival, the consignee that was travelling with it, perhaps the captain of the ship, would take the document and the goods to the banking house as the agent had directed, and there they would be paid. Then the bankers would try to sell the goods locally. They would then send some Italian goods back to their agent who in turn would sell these. Banking was a lot of import and export, and other than the movement of the initial seed capital, the primary representation of currency that travelled back and forth were those documents. Hard currency would occasionally be shipped on safe ships or galleys, which were typically operated by the merchant run governments of the Italian city states, especially those of Venice and Genoa, but the primary representation of changes in the capital assets of the branch bank or agent's books and those of the home office back in Italy were those documents. Money was moving without the hard currency going anywhere, and the profits were mostly hidden in those bills of exchange. This is because they were drafted or purchased in one currency and redeemed in another. During the life of a bill of exchange, it was the same thing as money, and could pass through several hands during its journey to its destination, which may or many not remain in the company of the trade goods with which it was originally associated.
Of course this had a huge built-in problem. Those documents or "bills of exchange" were promises to pay in hard currency, of which there wasn't enough to go around. It worked until an entire bank branch or all of the deposit customers of a bank branch wanted to cash out at the same time. And this happened too often because of the many wars and the three big calamitous events of the 15th century. On My 29, 1453 Constantinople fell to the Ottoman Empire. This disrupted the established trade relationships at the western end of the silk road. Banking factors or agents who were on the wrong side simply disappeared. Some fled home. Some were killed. And others simply went missing. So the bills of exchange that were in circulation stopped moving. On one end, what little hard currency there was typically was seized by the victors. On the other end, demands for payment could not be satisfied. Banking reserves tended to run in the 10% range meaning that a full 90% of the money in circulation was just bits of paper promising to pony up the gold and silver when demanded.
It got worse in 1492 which was a really bad year for Italian business - much worse than 1453, and it had nothing to do with that little sea voyage across the Atlantic that Ferdinand and Isabella sponsored. No, it was something that the two of them did earlier that year. On January 2, 1492 they completed the Reconquista and took possession of the Granada. They then put an end to tolerance of non-Christians that had been the norm in Spain under the Moors, and gave the Moors who did not escape and the Jewish population a choice, get out, convert, or be executed. And, not all of those who chose conversion were sufficiently convincing. This was huge disruption to Italian trading.
The many medieval bankruptcies by merchants and bankers created a widely held belief that hard currency was safer than any paper alternative. This was not altogether unjustified because those bills of exchange were not the standardized thing that the Chinese had attempted centuries earlier. That said, there was a secondary hard currency monetary system that was evolving that was causing some money to leak into the lower ranks of society. So let's take a look at the way many, but not all, European common folks were socialized from at least the time of the early Greeks sometime between 2,000 and 1,000bce.