The first form of Paper Money is commonly believed to have originated in China. Prior to this coins were the known currency, these had rectangular centers. When the coins got too heavy for a rich man to carry about usually stringed together with a rope, he would keep his money with a trusted gentleman, who would issue him a paper note with the amount of coins in his keep noted on it. This served as a promissory note, sufficient enough for a trader to release his goods to the merchant or rich man. If the trader showed the paper he could get his money, and so the first bankers were born.
It is known that in the 600's there were local issues of paper money in circulation in China. I find it very interesting to find that Western Civilization actually trails behind the east in the invention of paper money.
From this system "jaozi" paper money was born, when in 960AD the Song Dynasty started circulating paper notes as there was a shortage of copper used for making coins. This was the first time a governing body issued paper money for circulation as a means of official monetary exchange.
Thus numismatic scholars generally agree that China is the birthplace of Paper Money.
"Jaozi": World's first known Paper Money
Here is an account relating to this period given by one of the great explorers, Marco Polo:
All these pieces of paper are issued with as much solemnity and authority as if they were of pure gold or silver; and on every piece a variety of officials, whose duty it is, have to write their names, and to put their seals. And when all is prepared duly, the chief officer deputed by the Khan smears the seal entrusted to him with vermilion, and impresses it on the paper, so that the form of the seal remains imprinted upon it in red; the money is then authentic. Anyone forging it would be punished with death. And the Khan causes every year to be made such a vast quantity of this money, which costs him nothing, that it must equal in amount all the treasure of the world.
Furthermore all merchants arriving from India or other countries, and bringing with them gold or silver or gems and pearls, are prohibited from selling to any one but the emperor. He has twelve experts chosen for this business, men of shrewdness and experience in such affairs; these appraise the articles, and the emperor then pays a liberal price for them in those pieces of paper. The merchants accept his price readily, for in the first place they would not get so good an offer from anybody else, and secondly they are paid without any delay. And with this paper money they can buy what they like anywhere over the empire"
This way the emperor was able to fund the occupation of China without restrictions and unknowingly started inflation and hyperinflation because the supply of paper currency in the economy was over explosive. Thus we learn that the Chinese civilization of old was a thriving capitalist society.
It was the Ming Dynasty(1368-1644AD) that brought everything to an early end for China, in an effort to curb inflation and economic expansion, they stopped paper money completely and put an end to China's Trade. Talk about extremities, China went from boom to burst in it's creation of paper money.