Legal tender laws

Government coercion is pervasive in modern society, and seems to be growing daily. Whilst governments of old would not have cared to regulate your diet or how long you left your horse and cart at the market, states have always manipulated the money supply.
Legal tender laws are an ancient tool for governments to force their preferred currencies into circulation, and to drive out free market alternatives.

Kings and caesars did not print money, but instead debased their currencies through a  gradual process, sometimes by chipping away at gold coins, sometimes they mixed in base metals along with the gold, reducing the value of the coins. If there were no legal tender laws, these debased currencies would have been increasingly abandoned and replaced with a more stable and trustworthy market based money.

How do these laws ensure the rulers could impose these unreliable currencies on an unwilling populace? Often, any other form of money is banned, which is certainly the simplest approach. But this is hard to enforce, and a black market is likely to emerge.

Instead legal tender laws work by declaring that any individual or business must accept the government’s chosen currency. If I come to you with a £5 note, you have no choice but to accept it for a sale, even if you believe it to be a worthless piece of paper.

This drives out ‘good’ currencies, in a process known as Gresham’s Law. The legal tender laws give the same face value to the old coin, perhaps 100% gold, and the new coin, say 90% gold. Consumers tend to hold onto the more valuable currency, and instead spend the debased currency, since the face value is the same. The same process happens when fiat paper money is introduced.

The law is named after Sir Thomas Gresham, who observed Henry VIII debasing the silver penny to 1/3 of its original purity. The result:

It may please your majesty to understand, that the first occasion of the fall of exchange did grow by the King majesty, your late father, in abasing his coin … which was the occasion that all your fine gold was conveyed out of this your realm.

Debased currencies always result in inflation, since there is more currency going after the same quantity of goods and services. Prices rose, and the ruling monarch typically earned a huge profit.

It is important to note a common misunderstanding of Gresham’s Law – it is not that “bad money drives out good” but rather than “bad money drives out good under legal tender laws”.

Abolishing legal tender laws is therefore a key step to a free market in money, and could be a useful first step before ending the Bank of England itself. The competition forced by the ending of legal tender laws would encourage the BoE to adopt a less inflationary position, and reduce its ability to wreak havoc on the nation through its manipulation of interest rates. The history of government-controlled money is not a favourable one.

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2 Responses to Legal tender laws

  1. Pingback: Your Questions About Copper Prices 2010

  2. Pingback: Gresham’s law | Bell Book Candle

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