Economic Perspectives 54 – April 2019

Few people understand the purpose of so-called “legal tender”. It is widely believed that the government’s legal tender laws protect citizens’ money by formally designating it as the official medium for the settlement of transactions. The Latin root is “tendere”, to reach out, which includes its commercial meaning, “offer”, so that if you offer to settle a debt by paying in legal tender your creditor cannot then sue you for failing to repay your debt.

Since only the notes and coins of the realm constitute legal tender, our economic freedoms would be severely diminished if transactions could reliably be settled only in this way.

It would, for example, mean that other common and equally acceptable means of settlement, such as cheques, credit cards, direct bank transfers, or even silver and gold coins, none of which fall within the definition of legal tender, could not validly be used for payments – let alone any mutually agreed bartering of goods and services. It’s therefore no surprise that the real meaning of legal tender is simply currency that cannot legally be refused in payment of a debt – a negatively expressed definition. Any more elevated significance is therefore groundless.

Veneer without significance


Yet the grandiose epithet legal tender endows this simple meaning with a veneer of great economic significance that masks the fact that it actually isn’t needed at all, given that parties to any transaction are at liberty to agree between themselves the method and means of settlement which, these days, is extremely unlikely to be in the form of legal tender.

The great cover-up

How, then, did the notion of legal tender originate? The cloak of respectability implicit in the phrase “legal tender” is nothing more esoteric than a ploy devised by central banks to endow their fiat currencies with a credible, albeit bogus, provenance. Just consider: even if money has been “quantitatively eased” from thin air by the click of a computer key, or generated from nowhere by the fraud known as fractional reserve banking, once it receives the central bank’s blessing and is anointed “legal tender”, it must be accepted as such.

No powers of reasoning are required: even if everyone knows it is based on pure fakery, it must be accepted because it’s – well – accepted! Until, that is, it isn’t accepted any longer.

Worthless, but still legal tender!


Examine a 50,000 Bolivar banknote, courtesy of the government of Venezuela, or a 100-trillion dollar Zimbabwe banknote. Their appearances are authentic enough; the notes are coarse and gaudily embossed with whirls and images of past heroes and glories. In those countries, they are undoubtedly designated “legal tender” status despite the fact that at 650,000 bolivars to the US dollar, and 100 trillion Zimbabwe dollars equating to 40 US cents, their utter uselessness as currencies is plain.

As a child living in South Africa I well remember seeing the massive yellow ridges of “mine-dumps” as we approached Johannesburg from Pretoria, and being told that they were made of earth thrown up from the goldmines deep below the ground. The “rand” was the ridge of high ground on which stood the goldmining towns of Boksburg, Brakpan, Benoni and Springs. How ironic that when South Africa gained independence in 1961 its new currency was named the rand, a name that connoted such powerful links with the gold from which South Africa derived its huge wealth.

Loss of purchasing power against gold


At its launch it was convertible at the rate of 2 rand to £1.5 and, by the hyperinflationary standards of most other currencies, it has done better than most with £1.5 now converting to 30 rand, a debasement rate against the pound of a mere 1,500 per cent – but since the pound itself has suffered major debasement over that period, the rand’s true loss of purchasing power since its inception would have to measured against a stable point of reference, such as…!

Traders choose their own medium of settlement

Our common understanding of legal tender laws therefore misses the important point, which is the view of the parties actually involved in trade. Since the role of money is to facilitate settlement of dealings between purchasers and sellers of goods and services, governments may pronounce, decree and pontificate until the cows come home to the effect that a particular medium constitutes the nation’s legal tender, but if neither its citizens, nor their trading partners, trust it they won’t use it. They will make up their own minds on which medium to choose for settling bargains.

There have been cries heard in Greece, Spain and Italy to the effect that that their desperate economic woes would be solved if only they could replace the euro with the drachma, peseta or lira! But try asking them whether those with whom they trade would accept newly minted drachmas, pesetas or lira as payment for real goods and services. Any currency, whether designated legal tender or not, is only as good as its acceptability in trade.

Pat’s meeting with Fed’s PR team


The central bank and the central illusion

The dictum “any government that can print money will print money” reminds me of Patrick Barron’s account of his meeting with the Federal Reserve’s public relations team shortly after the 2008 sub-prime lending disaster. After the team’s predictable eulogy on the Fed’s measures to rescue the banking system, Pat innocently enquired whether the Fed had exercised its power to increase the money supply, which team-Fed duly confirmed. Pat then asked: “And the money that you created was generated out of thin air. It wasn’t there before, but it’s there now. Is that right?” [Also conceded, nervously.]

Pat: “And you say that creating this money out of thin air is beneficial to the economy. Is that right?” [Conceded, still more nervously.]

Pat: “Then why do you prosecute counterfeiters?” [Meeting terminated.]

Pat’s serious point is that there is absolutely no difference in the economic consequences to society between the central bank creating money out of thin air and a counterfeiter doing the same thing. The sole difference concerns legality and scale. Whereas private counterfeiters are, rightly, prosecuted, the central bank earns praise for its actions.

The reason that counterfeiters are punished is because printing money is a form of theft: in order to benefit, the counterfeiter must pass his fake money to another person in exchange for valuable goods or services. Put simply, this amounts to getting something for nothing, or a transfer of wealth from those “down the line”, with whom the fake money finishes up, to those who received it first – the counterfeiter and the Fed.

The “Cantillon effect”

The French economist, Richard Cantillon, was one of the first to observe that the first receivers of the new money benefit at the expense of all subsequent receivers. Since inflating the money supply must always push up prices, its first receivers are able to spend it before its price-inflationary effect has taken hold; whereas subsequent receivers now have to bear those higher prices. This is known as the Cantillon effect. Hence my comment that counterfeiting, whether by a central bank or a criminal with a printing press in his basement, always represents a transfer of wealth.

Printing money can’t increase wealth


It is abundantly clear that printing money cannot increase wealth. In fact, the disruptive effect on business decision-making of inflating credit while suppressing interest rates is wealth-destructive, and a major cause of malinvestment.

Central banks are adept in hiding the destructive effects of money printing by highlighting its benefit to particular sectors that are favoured such as, currently, the Chancellor’s “Help-to-Buy” scheme. Some were undoubtedly helped, but the extra money has pushed up new house prices, increased builders’ margins and enriched the executives of house-building giants such as Persimmon.

Malign use of statistics

Official statistics are used as a handy tool for masking real policy impacts. The most favoured is, as ever, that mythological creature named Gross Domestic Product (GDP). GDP is simply a monetary total of all recorded qualifying transactions during a stated period, usually a year. Therefore, as Alasdair Macleod regularly points out, GDP “growth”, is merely the sum effect of money inflation on the prices that make up all those transactions.

Hong Kong growth


Sir John James Cowperthwaite, who as financial secretary guided Hong Kong to undreamed of prosperity, banned the collection of economic statistics since “they might encourage people to interfere in the economy”!

I referred above to the so-called “Cantillon effect” of what must happen whenever vast quantities of fake money are injected into the banking system. The point is that this imposter, the new money masquerading as legal tender for all, must go somewhere, and its first receivers can’t get rid of it quickly enough – almost as if their recognition of its falsity impels them to convert it into tangibles – usually property, property-based equities, commodities and luxury baubles of every description – before the riches nouveau evaporate before their very eyes.

And it is hardly surprising that this swirling money-fountain also explains the vastly inflated executive pay packages that sicken observant onlookers to the core. The disgust felt by any rational citizen beholding the multiples of largesse that can scarcely be claimed as having been earned, is a public disgrace and a scourge on the wider-working community.

Cantillon & the rich/poor gap


The phenomenon is rampant internationally too. I have referred to the catastrophic level of currency debasement in South Africa – again due to perennial money printing on a massive scale by its central bank. The Cantillon effect of benefitting the first receivers accounts for the fact that the richest 10 per cent of South Africans (less than half of them white) own almost 95 per cent of the country’s wealth.

Who would have guessed that the cause of this socially divisive phenomenon lies not with corrupted remuneration committees, but with their countries’ treasuries and central banks?