Last Updated on October 7, 2024
Fiat currency is a type of currency that exists only by government decree.
It refers to the nature of the currency being untethered to a commodity with new units being easily created at will.
Legal tender is a status that a government bestows on a currency, stating that it must be accepted by merchants and can be used to pay taxes.
A fiat currency is normally legal tender. If it wasn’t, people wouldn’t use it and would use hard money instead.
This is a fact that even the Fed agrees with. St. Louis Fed economist David Andolfatto notes:
“Under a fiat money system, a dollar is just an accounting unit. A dollar bill is no longer made redeemable in gold or any other asset. However, paper money is stipulated as legal tender. That is to say, people can legally pay their debts, including taxes, using paper money. So paper money circulates because it is convenient as a payment instrument and it can be used to discharge debt.”
However, legal tender does not have to be fiat currency.
Anything could be declared legal tender, such as gold or Bitcoin. Yet hard money that is accepted by the market does not need legal tender laws to make it money.
It just needs the absence of government restrictions, and it will flourish on its own.
The U.S. dollar is an example of a currency that is both a fiat currency and legal tender.
Bitcoin has been granted legal tender status in El Salvador, so that is an example of money that is legal tender but not a fiat currency.
A Brief History of Legal Tender
There were no legal tender laws in the early history of the United States.
The 1792 Coinage Act gave Congress the power to coin money and established the US Dollar as the nation’s monetary standard, defining the dollar as 24.1g of pure silver.
The first legal tender law was passed in 1862, during the Civil War.
In 1861 and 1862 the Union has issued “demand notes.” This was a paper currency but redeemable in gold and silver on demand.
However, the government quickly realised that if it wanted to finance the war through paper money they had to end free convertibility to gold and silver.
So the 1862 Legal Tender Act was passed, replacing “demand notes” with United States Notes that were not convertible to gold or silver.
Demand Notes and United States Notes collectively became known as Greenbacks.
The 1862 Legal Tender Act had the effect of ending the nation’s bimetallic standard and establishing a paper money standard.
Like most paper money experiments, the government had only planned on one emergency issue of United States Notes. It was supposed to be $150 million.
But the temptation to keep printing was too great.
A second $150 million was issued later in 1862 with a third $150 million issue in 1863.
This was highly inflationary.
With the advent of the Federal Reserve, a new type of paper money was introduced into the US called the Federal Reserve Note.
When people talk about the U.S. Dollar today, normally they are actually referring to the Federal Reserve Note.
The current legal tender law in the US says:
“United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues. Foreign gold or silver coins are not legal tender for debts.”
This means gold and silver coins are also legal tender. However, since the market value of the metal is substantially higher than the stamped face value on the coins in practice nobody uses them as such.
Moves To Make Gold Legal Tender In Some States
Over the last decade as the fiat system falter, several states in the US have either passed or attempted to pass a law that either recognises gold and silver as legal tender or exempts them from taxation.
These states are:
- West Virginia
- Wyoming
- Utah
- Arizona
- Kansas
- Oklahoma
- Texas
- Indiana
- Missouri
- Louisiana
- Tennessee
- South Carolina
It is capital gains tax that prevents any form of hard money being used as a circulating currency and changes it into an investment asset. If we could freely use hard currency without needing the hassle and expense of calculating and paying tax then people might start adopting it as a day to day currency.
In a similar way, El Salvador has declared Bitcoin to be legal tender, ensuring that people can use it without accruing tax obligations.
Conclusion
Fiat currency and legal tender are not the same thing.
Fiat currencies are legal tender but legal tender does not always mean fiat currencies.
Fiat currencies exist by decree and therefore they need legal tender laws in order to enforce their use. Without the coercion applied by legal tender laws it is likely that people would freely select hard money over fiat currency.
Legal tender can be applied to any form of money, even hard money such as gold, silver or Bitcoin. However, hard money does not need legal tender to thrive. As long as the government does not place restrictions on the use of money through capital gains taxes, humans will naturally gravitate towards the hardest money available to them, regardless of whether it has been declared legal tender or not.
Image Credits:
US Dollar by Emilio Takas on Unsplash
