Paper money was originally receipts for gold coin which was stored in warehouses in medieval Europe. These warehouses were the first banks and the receipts, redeemable in gold, were loaned at interest and used as a gold substitute. Until recently, our treasury and banks, including the Federal Reserve banks, stored gold and issued paper money redeemable in gold. Banks would loan a ratio of paper money greater than gold reserves, but were restrained by the quality of the loans and the ability of the borrower to pay back. The gold reserve in a free banking system, with Congress regulating the value, was a means of insuring conservative policy in terms of the issuance of paper money and a natural check on inflation.
Inflation is what happens if more paper money is spent into the economy than production of wealth.
The result of inflation is a devaluing of the workingman's dollar and a subsequent need to increase the price of goods and services to keep up. Deflation happens if not enough money is in circulation to keep up with production. The result is a contraction in business growth and unemployment. Our monetary system was a based on the gold standard until the passage of the Federal Reserve Act of 1913. The pre-1913 system would experience occasional, short lived recessions as sometimes, private banks had trouble maintaining enough gold reserves to keep up with the demands of business and would come up short.