What is paper money used for?

Answer 1

To buy stuff

Well, yes, but....

Paper money is what's called a medium of exchange. That means it provides a common and consistent way for people to translate the value of one thing into the value of another without having to make an exact item-for-item match.

For example, in a barter economy if you wanted to get a chicken and some vegetables from a farmer you'd have to give the farmer something he valued at exactly the same level in exchange. It might be work, it might be some wood, and so on. If you couldn't come up with an exact match - say the farmer didn't need those things right away or you couldn't agree on a fair exchange - the deal would be off.

However if you use money as a medium of exchange, the value of your goods or services can be expressed as a specific amount of coins, bills, etc. The farmer similarly expresses the value of his products in the same types of coins and bills. Because money is "generic"; i.e. it can be used to value anything, you and the farmer no longer need to have a specific agreement on trading one set of items for another. The farmer can receive your money and keep it for later use rather than expecting you to provide something he needs at the moment. In the same way, your worth (work, goods, etc.) is translated into something that the farmer can accept at a known value.

So, at least before things like checks, credit cards, and electronic payment was developed why did people use paper money used instead of metals like gold, silver, or copper? The most important reason is simply practicality. As economies grew, businesses developed and governments became more important. Doing something like buying tons of timber or paying an army would require that large amounts of metal be mined, made into bars or coins, and transported over increasingly-great distances. Paper currency uses a light, readily-transportable substitute for metal currency to enable large sums to be moved and distributed easily.

The economic risk of paper currency is of course that the amount that each unit represents can become "decoupled" from some intrinsic measure of value that would otherwise stabilize its buying power. In the past that intrinsic measure was almost always a precious metal such as gold or silver while today it's more complex, involving links to things such as productivity, exchange rates, etc. Across history there have been times that governments have fallen for the temptation to simply print paper money without regard to that linkage, thus lowering the purchasing power of each individual unit; i.e. inflation. The most egregious cases occurred in Weimar Germany during the 1920s and Zimbabwe during the 2000s, when so much paper money was issued that it became worthless almost as soon as it was printed. Most larger economies have central banks whose duties include trying to minimize the risk of such events happening again.

Today paper money makes up only a small part of most industrial economies. It's mostly used for smaller purchases like food, appliances, basic services and so on while larger amounts are handled electronically.