Paper Money And Promissory Notes

Gold Nuggety Nugget

Coins and promissory notes have been around for a long time. Paper money or Fiat Money dates back to the Song dynasty of China in the 11th century when the government created promissory notes or money subject to be redeemed for gold within 3 years. In reality the notes were never redeemed, and when more notes were printed than there was gold to back them, Inflation ensued.

There was a time when independent banks were trusted to keep the value of promissory notes stable. If one bank did the wrong thing and gave out more promises to deliver the money, than they had money on hand, it affected only the people who dealt with that bank.

For a long period in history governments created laws that gave them the monopoly to create money for the citizens to use, and that money was backed by gold (e.g.In the USA Gold was stored in Fort Knox ).

Gold is hard to get, and it follows a similar law to the Physics law of Energy. "Energy (or Gold) can be neither created nor destroyed, but simply changes from one form to another.(nuggets, bullion bars, coins, jewellery, gold fillings in teeth etc).
If there was a sudden increase in the amount of Gold a country had, inflation would follow. A good example of this was when Spain brought its gold plunder from South America back to Spain.

What gold backing for money does, is provide a brake on the amount of money available.  Fiat money on the other hand is declared as legal tender by a government, but is not backed by gold or any other commodity (pearls, cowrie shells etc). The only reason it has any value is because the government accepts Fiat money for payment of taxes and debts, and so does most of the population.