Paper money was developed first by the Chinese, who used stag skins, bark, or parchment marked with the imperial seal as "bills of payment." The penalty for counterfeiting was death.
Paper money had trouble gaining acceptance in Europe. Leather money was used around 1100, but only as a temporary substitute when silver supplies ran low. A Swedish bank issued paper money in 1661, but they eventually flooded the market with it, and it lost its value.
The use of paper money really caught on in Europe in the 1700s, when the official bank of the French government began issuing paper money. The idea came from goldsmiths, who often gave people bills of receipt for their gold. The bills could be exchanged for the gold at a later date. That's an important fact in the development of paper money, because it means that the money represented a real amount of gold or silver that actually existed somewhere. A piece of money was actually a promise from the institution that issued it (either a government or a bank) that the institution would give the holder of the bill a certain amount of gold or silver from its stockpile whenever he wanted it. Under this kind of system, the money is said to be "backed by gold." With a few temporary exceptions, during wars or other emergencies, all currency in the world was backed by a real supply of precious metal until 1971.