Fiat currency first emerged when the Yuan Dynasty of China started to print paper money without restrictions on duration, in order to fund their reign in the absence of sufficient specie. This led to hyperinflation. Eventually, by the mid-15th century, the new Ming Dynasty stopped printing paper money altogether in order to contain both hyperinflation and economic expansion.
Fiat Currency in the West
The first instance of fiat currency in the West came about when the issuing of paper money in Sweden was taken over by the Scandinavian country’s government. This happened in the latter half of the 17th century. Although paper money was inconvertible to specie by 1745, the government mandated its acceptance.
In the Thirteen Colonies, an early form of fiat currency was known as bills of credit. Notes were produced by provincial government, with the promise that holders would be allowed to pay taxes with those notes. The notes were issued for the purpose of paying current obligations and were called by levying taxes at a later point in time. They were circulated between individuals in non-tax transactions because they were denominated in the local unit of account. The colonies where bills of credit were most prevalent were Massachusetts, Pennsylvania and Virginia. The money was sold at a discount of silver, which was then spent by the government. It expired at a pre-agreed later time. Other colonies that had this fiat currency included New England and the Carolinas, where the bills of credit depreciated more dramatically than anywhere else.
As colonial powers continued to introduce fiat currencies backed by taxes such as poll taxes or hut taxes, a cycle of deflationary hard money followed by inflationary paper money continued repeatedly for the majority of the 18th and 19th centuries. The reason why the authorities kept introducing fiat currencies backed by taxes was because they needed to mobilize economic resources in their new possessions, in the context of a transitional arrangement, at least. The Federal Government introduced United States Notes during the course of the American Civil War. These represented a form of paper fiat currency that came to be commonly known as greenbacks.
World War One and Beyond
Although most governments had a legalized monopoly on bank notes and the legal tender status thereof by 1914, most of them still promised to redeem notes in specie on demand. However, as the war wore on, authorities moved to suspend redemption in specie due to the high costs of the military conflict and the accompanying policies of huge expansion. Due to a lack of direct penalty for doing so, governments were not directly responsible for the economic effects of printing more money. This inevitably led to hyperinflation, perhaps most notably in post-war Germany.
In consequent attempts to regain economic stability, pure fiat currency was combined with a form of convertibility via gold bullion exchange. This was done with the purpose of anchoring currency to gold bullion under the Bretton Woods system. This system was established in 1945, after an agreement was made at the Bretton Woods Conference to fix the value of 35 US dollars to one troy ounce of gold and then peg other currencies to the US dollar at fixed rates. This system lasted until 1971, when it collapsed as a result of President Richard Nixon ending the convertibility of the US dollar for gold.
Fiat currency has caused drama throughout history and does so to this day, if only theoretically. Nowadays, critics of fiat currency claim that the United States could use it as a dangerous financial weapon, as much of the rest of the world currently holds US debt and US dollars as central bank reserves. According to the supporters of this argument, fiat money could be printed in the US to cover its debts abroad, yet creditors are unable to sell the devalued US dollar off because doing so would destroy the purchasing power of their own dollar-denominated collections from the United States. It certainly is quite the conundrum.