Paper money is light.  It’s easy to carry and convenient for large transactions.  Unlike gold, it doesn’t weigh you down or put you at risk of theft.  Yet its convenience hides a fundamental flaw.  Unlike gold, paper money has no intrinsic value.  Its worth depends entirely on trust—trust in the issuer and in the system that circulates it.

Paper money started as a claim.  Banks issued notes representing gold or silver deposits, promising that these could be redeemed on demand.  This was the origin of cash as we know it.  At first, these notes were backed by real money.  They served as a practical substitute, enabling commerce without the need to lug heavy metals around.

Over time, the system evolved—or devolved.  Banks discovered they could issue more notes than they had gold to back them.  These were no longer true substitutes, they were promises without sufficient means to fulfill them.  This practice, known as fractional reserve banking, created what is called fiduciary media: paper claims to money that does not exist.

The incentive for banks was clear.  By lending out more than they held in reserves, they could earn interest on money they didn’t have.  This gave them a competitive edge—provided no one demanded their deposits all at once.  The risk of exposure was always present.  If one bank’s dishonesty came to light, others might follow, triggering a collapse.

To mitigate this, banks formed cartels.  These agreements ensured that no member would call out another’s overextension.  Cartels are fragile.  Trust among competitors is tenuous, and the temptation to break ranks looms large.  The ultimate solution was state intervention.  By creating a central bank—a bank of banks—fraudulent practices were legitimized under the law.

With legal backing, the game changed.  The state guaranteed the redeemability of banknotes, but not their value.  This distinction is critical.  You can withdraw your cash, but the purchasing power of that cash is not fixed.  Deposit insurance became a comforting illusion, masking the underlying instability.

The result?  Inflation.  By issuing more fiduciary media, banks increase the money supply without increasing real wealth.  More money chases the same amount of goods, eroding value and creating economic distortions.  What began as a tool for convenience has become a driver of economic cycles, booms, and busts.

Fiat money, untethered from real value, is paper in every sense—light, convenient, and ultimately flimsy.  Its creation is not wealth but illusion, and its widespread use ensures that inflation and instability are woven into the fabric of modern economies.

Reference

Ludwig von Mises; Human Action