The Legal Tender Cases, were a series of United States Supreme Court cases in the latter part of the nineteenth century, affirming the constitutionality of paper money. For details about the facts and holdings of those particular cases, see Knox v. Lee and Parker v. Davis in 1871 (79 U.S. 457), as well as Juilliard v. Greenman in 1884 (110 U.S. 421). The Legal Tender Cases overruled the Court's decision in the 1870 case of Hepburn v. Griswold which had held that paper money violated the United States Constitution.
The Legal Tender Cases primarily involved the constitutionality of the Legal Tender Act of 1862 enacted during the Civil War. In Hepburn v. Griswold (1870), Chief Justice Samuel Chase, held for a 4-3 majority of the Court that the Act was an unconstitutional violation of the Fifth Amendment. Ironically, Chief Justice Chase had been involved in enacting the Legal Tender Act, in his previous position as Secretary of the Treasury.
Immediately following Hepburn, President Ulysses Grant then nominated two new justices to the Court (Joseph Bradley and Strong) who reversed that decision, in Knox v. Lee and Parker v. Davis (1871), by votes of 5-4. The constitutionality of the Act was more broadly upheld in Juillard v. Greenman (1884).
Paper money in the United States did not begin with the Legal Tender Act of 1862. For example, in 1789, Congress chartered the First Bank of the United States, and authorized that bank to issue paper bank notes. James Madison had written in 1787 that the Constitution "would not disable the Govt from the use of public notes as far as they could be safe & proper...."
The Legal Tender Cases also had further support in the language of the Constitution. For example, Article I, Section 9 of the Constitution explicitly forbids the states from making anything but coins "tender in payment." However, there is no corresponding explicit prohibition against the federal government, and in fact Elbridge Gerry’s motion at the Constitutional Convention to adopt such a prohibition against the federal government was defeated.
Another representative at the Constititonal Convention, Nathaniel Gorham, said that he "was for striking out" an explicit power of Congress to issue paper money, but Gorham was also against "inserting any prohibition." That is what ultimately happened at the Convention.
Gorham explained that Article I, Section 8, Clause 2 would enable Congress to "borrow money on the credit of the United States." He therefore envisioned that "The power [to emit paper money], so far as it will be necessary or safe, will be involved in that of borrowing." In other words, the power arises from the Necessary and Proper Clause in combination with the power to borrow money.
Nowadays, paper money is created in the United States when Congress sells U.S. Government Securities to pay interest on the national debt; the Federal Reserve then buys some of those U.S. Government securities on the open market, by issuing new money. Article I, Section 8, Clause 6 of the Constitution explicitly contemplates U.S. Government "securities."