Paper money has a unique place in the history of the United States. The lack of bullion experienced by the British colonies in North America created an ideal setting for the first authorized government-backed issue of paper money in the western world.
In 1690, the Massachusetts Bay Colony approved the issuance of the first paper money in North America, and the first to be issued directly by a government in the West. Other colonies followed Massachusetts' lead until paper money became common in the colonies, and was mostly successful, despite attempts by the British government to suppress its use.
The American Revolution witnessed a vast expansion in the issue of paper money by provisional state governments as well as the new Continental Congress as they attempted to cover the costs of the war.
Over-issuance caused the collapse of the currency so that by the end of the Revolution, the American public had lost confidence in paper money. Continental paper was eventually redeemed at one cent on the dollar, three decades after it was issued.
In 1789, the Constitution prevented the individual states from issuing paper money and the Federal government was reluctant to issue paper money due to past experience.
Thus, Federal treasury notes were only issued during emergencies such as the War of 1812 and the Mexican-American War. However, the continued lack of sufficient silver or gold coinage made paper currency necessary for the economy to grow. Banks chartered by individual states and corporations provided the answer by issuing paper money, now known as obsolete notes.
At the outbreak of the Civil War, the Federal Treasury realized that a new paper money system was needed. New methods for raising money were established, including the creation of a permanent Federal system of paper currency.
Congress authorized the issuance of regular circulating paper money in 1861 for the first time since the Revolution. Known as "demand notes," these were redeemable in hard cash on demand.
In 1862, demand notes were replaced by Legal Tender notes, and, in 1863, by Compound Interest Treasury notes. These notes became known as "greenbacks" due to their green color.
In 1863, the National Banking Act was introduced to replace the obsolete state-chartered banknotes with a reliable, standardized series of notes issued by national banks backed by government bonds deposited with the Treasury.
By the second half of the 19th century, the United States was producing the finest and most stable bank notes in the world. American paper money became the model for many countries, and American concepts of how paper money should look became the accepted standard for most of the world.