Almost 750 years ago, a young Venetian merchant named Marco Polo wrote a remarkable book chronicling his travels in China.

The Book of the Marvels of the World was full of strange foreign customs that Marco claimed to have seen.

But there was one that was so extraordinary, Marco Polo could barely contain himself: "Tell it how I might," he wrote, "you never would be satisfied that I was keeping within truthand reason."

What had excited Marco so much? He was one of the first Europeans to witness an invention that remains at the foundation of the modern economy: paper money.

Of course, the paper itself isn't the point. Modern paper money isn't made of paper - it's made of cotton fibres or plastic.

And the Chinese money that so fascinated Marco Polo wasn't quite paper either.

It was made from a black sheet derived from the bark of mulberry trees, signed by multiple officials and, with a seal smothered in bright red vermilion, authenticated by the Chinese emperor KublaiKhan himself.

The chapter of Marco Polo's book was titled, somewhat breathlessly: "How the great Khan Causes the Bark of Trees, Made into Something Like Paper, to Pass for Money All over HisCountry".

The point is, that whatever these notes were made of, their value didn't come from the preciousness of the substance, as with a gold or silver coin.

Instead, the value was created purely by the authority of the government.

The genius of this system amazed Marco Polo, who explained that the paper money circulated as though it were gold or silver itself. Where was all the gold that wasn't circulating? Well, theemperor kept a tight hold of that.

The Mulberry money itself wasn't new when Marco Polo heard about it. It had emerged nearly three centuries earlier, around the year 1000 in Sichuan, China.

Sichuan was a frontier province, bordered by foreign and sometimes hostile states. China's rulers didn't want valuable gold and silver currency to leak into foreign lands, and so theyimposed a bizarre rule. Sichuan had to use coins made of iron.

Sichuan merchants had a problem, as William Goetzmann explains in his book Money Changes Everything. It was illegal to use gold and silver coins, and impractical to use iron coins. It's nosurprise that they began to experiment with an alternative.

That alternative was called "jiaozi", or "exchange bills". Instead of carrying around a wagonload of iron coins, a well-known and trusted merchant would write an IOU, andpromise to pay his bill later when it was more convenient for everyone.

That was a simple enough idea. But then there was a twist, a kind of economic magic. These "jiaozi", or IOUs, started to trade freely.

Initially, the government-issued jiaozi could be redeemed for coins on demand, exactly as the private jiaozi had been. This was logical: it treated the paper notes as a placeholder for somethingof real value.

But the government soon moved stealthily to a fiat system, maintaining the principle but abandoning the practice of redeeming jiaozi for metal. Bring an old jiaozi in to the government treasury tobe redeemed, and you would receive a crisp new jiaozi.

That was a very modern step. The money we use today all over the world is created by central banks and it's backed by nothing in particular except the promises to replace old notes with freshones.

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