Legal Tender Renders Planning Impossible

There is much confusion over what the legal tender law does. I have read articles, written by people who are otherwise knowledgeable about economics, claiming that legal tender forces merchants to accept dollars under threat of imprisonment. Recently, I wrote a short article for Forbes clarifying how legal tender law works in the US.

Legal tender law has nothing to do with merchants. If you want to sell steak dinners in your restaurant for silver, you may legally have at it. Unfortunately, the tax code discourages your would-be customers as I wrote in another article.

The legal tender law targets the lender. It grants to debtors a right to repay a debt in dollars. In practice, this means that if you lend gold, the debtor gets a free put option at your expense. If the gold price rises, he can repay in dollars. If it falls, of course he will be happy to repay in gold. It’s a rotten deal for the lender.

The relationship between lender and borrower is mutually beneficial, or else it would not exist. The parties are exchanging wealth and income, creating new wealth and new income in the process. The government is displeased by this happy marriage, and busts it up by sticking a gun in the lender’s face. His right to expect his partner to honor a signed agreement is violated.

Because no lender will lend gold under such circumstances, gold is relegated to hoarding and speculation only. This strikes a blow to savers, because the best way to save is to lend and earn interest. Savers are forced to choose between hoarding gold, getting no yield, or holding dollars and getting whatever yield crumbs are dropped by the Fed.

If there’s no lending in gold, what takes its place? The Fed force-feeds credit in ever-larger amounts, and at ever-falling interest rates.

The Fed is supposed to make its credit decisions in order to optimize two variables. First, employment shouldn’t be too high or too low. Second, consumer prices shouldn’t rise too quickly or too slowly. The Fed has little ability to predict employment and prices, and even less control over them.

Most Fed critics focus on the quantity of money. Is there too much, or too little? Is the rate of increase too fast or too slow? Is monetary policy too tight or too loose? Lost in this noise is any discussion of who the lender is.

If you buy Treasury bonds, then you know you are lending to the government. You are enabling welfare spending, and a few cases of lending to such worthy activities as housing speculation.

What if you don’t? Well if you deposit dollars in a bank, you are funding the bank’s purchase of Treasury and other bonds. You know, or reasonably ought to know, that this money is being lent.

But suppose you don’t even do that. Suppose you keep a wad of dollar bills under the mattress. You are still lending. The dollar is the Fed’s credit paper. You are financing the Fed’s activities, which consist of buying Treasury bonds and various other bonds.

You’re the patsy. You are the lender.

Anybody who wants to earn dollars is bringing demand for dollars to the market—in other words, making a bid on dollars. With what do they bid? They bid with their labor, with tangible goods, and with land. All assets today are bidding on the dollar, though most people look at it inside out. They think that all assets are offered for sale at the right price.

In any case, this universal bid on the dollar provides credit to the Fed. By placing wealth in the Fed’s hands, everyone gives it their savings to lend out.

Forget about what this does to consumer prices. There are much more serious implications. In place of the delicate, mutually beneficial relationships involved in lending, the Fed sucks the savings from the people, and pumps it out at high pressure. The Fed’s indiscriminate deluge of credit is not a substitute for individual thinking, planning, acting, and lending.

The consequence is incalculable destruction.

The legal tender law does not attack the ability to do a trade here and now, “cash on the barrel head.” It attacks something subtler but just as important. It destroys your ability to plan long range, to prepare for the passage of time. Time is a universal in the human experience. We all work during our adulthood with urgency, because some day we will grow old and be unable to work. To plan for that day, we save while we work and lend our savings to earn interest.

The motivation to borrow also comes from planning for the passage of time. The entrepreneur wants to start or grow a business now, while he has the opportunity, and energy. That’s why he is willing to pay interest out of part of his profits.

In a loan, the borrower gets money immediately, but the lender gets paid later. Time is an integral part of the deal, as one party prefers to be paid later.

In the free market, nothing comes between the saver and the entrepreneur. In central banking, by contrast, the legal tender law attacks the very heart of the free market, like an insidious poison. It disenfranchises the saver, enabling the Fed to plunder his nest egg and undermine his retirement plans.

At the same time, the Fed abuses the hapless entrepreneur too. It lures him to borrow with the promise of low rates, and then like Lucy pulling the football out from under Charlie Brown, cuts the interest rate again. This drives down his profit margin and plunders his capital.

Legal tender law takes away your ability to plan for the future. It replaces a hundred million individual decisions whether or not to have tea, with a giant high-pressure fire hose that blasts hot wastewater indiscriminately. No matter whether they open the spigot further, or close it slightly, the scalding deluge of Fed credit is not in any way equivalent to the individual planning, saving, and borrowing that would go on if we had a free market.

12 replies
  1. Greg Jaxon says:

    Reading this revisits the sort of sentiment “Man of La Mancha” tried to evoke – the heartbreak of seeing ideals hiding almost unreachable in the human tragedy. And worse yet, they are ideals others seem intent on not seeing. I have often thought that to set things right, it might suffice to transfuse the system’s vital liquid(ity): its money, as though that would impart the soundness and honesty now lacking. Yet this always comes back to the Legal Tender Acts, and the Supreme Court cases that upheld them. Then I remember that without a proper sense of how to discover Just Laws no “system” can survive humanity’s attraction to tragedy and heedlessness to unintended consequence. Even Austrian economists are not immune to this.

  2. mike n says:

    Excellent post on the deeper reasons behind wealth destruction. Do you ever get the feeling of a Cassandra? You can see the malevolent future of many actions and people but are ignored when you tell them? Keep up the good work!

  3. stustev says:

    You hit a home run – when I try to explain to people how they are the lender when they hold the legal tender dollars they respond is if I am talking out my ‘second mouth’.
    I like how ‘they’ borrow from us and then charge interest on what they loaned us. We have been living under negative interest rates for a long time now.

  4. waknpak says:

    Several months ago I tried to buy a $20 gift card at Starbucks by offering a $100 bill and was told we do not accept 100s. The manager said it was policy. I can see his point–not wanting to train employees how to recognize counterfeit $100s and running out of change by lots of people offering $100s for $3 cups of coffee. I asked him if I could buy 5 gift cards for $20 and he said yes but he was concerned that he could be reprimanded for disobeying company policy. I told him it was my understanding that legal tender laws compelled him to accept the cash as an offer to pay. Since I made a “good faith” effort to pay I could simply take the cards. That’s what legal tender meant. Personally, I think the company has the freedom NOT to serve whoever it wants but that is another issue….

    • mongoose33 says:

      I might be mistaken, but until they hand you the five $20 gift cards, there is no debt, and thus no obligation to accept the $100 bill? Just a thought.

  5. drdavis2 says:

    You write, “If the gold price rises, he [the borrower of gold] can repay in dollars…a rotten deal for the lender.” I don’t understand how this is a rotten deal, other than some inconvenience and commissions–is that what you mean? If the borrower repays in dollars, the lender can take those dollars and buy the same amount of gold that the borrower would have returned if he repaid in gold. Am I missing something?

    • Freeman says:

      the borrower has the option to repay the borrowed gold with his choice of two commodities, the amount of both fixed at the time of the loan, in this case gold or a commonly traded IOU called “dollars”. When the loan is due, the borrower decides which has more true value and repays the lender with the lesser of the two. Few lenders would willingly agree to such terms, as the borrower always has an advantage. Hence legal tender laws, which not only encourage borrowers (thereby encouraging the use of more currency), but gives a similar advantage to the issuer of the currency, who skims a part of every transaction.

      Difficult to change paradigms, n’est pas?

  6. Keith Weiner says:

    Thanks for the comments and questions.

    stustev: You may enjoy my series on interest and prices. I don’t remember which part, it may have been Part VI or VII, I discuss that the Fed does not “print” dollars. It borrows them. The individual parts are all here on the MM, but I made a handy-dandy single page to aggregate all 7 of them here:

    waknpak: That’s not right. Check out my Forbes article (linked in this one) about how legal tender targets the lender. The merchant is under no legal obligation to accept dollars at all, much less a particular bill denomination.

    drdavis2: As Freeman said, the dollar value of the gold loan is established at the time the loan is made. If the price of gold doubles, this dollar value does not. The borrower will pay the old dollar amount, which is half the gold equivalent at the time of repayment.

    Freeman: brilliant parting point about paradigm changes. A paradigm shift can typically be described in a sentence or three. However, it takes a lot more than that for the brain to flip to the new way of thinking. The idea that the dollar isn’t money is easy to say on a certain level. But even after hours of discussion, I get people asking me “yeah but in the gold standard, what would the gold price be?” It is going to take time and work!

    – Keith “Cassandra’ Weiner

    • stustev says:

      K. “Cassandra” W.,
      I read my post and saw a mistake.
      It should have read ‘what we loaned them’. I am reading the articles at the link you gave me and sharing them with my family and others.

  7. rpmartin says:

    So Keith,

    Does this legal tender maneuver pave the way for government “re-aquisition” of the peoples gold and silver, by forcing their sale at their original purchase price? In other words, three years from now, when gold hits $3850 oz and silver hits $125 oz, will an executive order get signed calling in all gold and silver from “hoarders” (or go to jail) with the government only required to pay the cost of their original purchase in fiat paper?

    Hmmm, with a Big Brother like this, I’d rather be an only child…

    RP Martin

  8. mossmoon says:

    “The merchant is under no legal obligation to accept dollars at all, much less a particular bill denomination.”

    The Starbucks merchant can refuse dollars by refusing to serve the customer, but that action doesn’t necessarily fall under legal tender laws. It’s my understanding that if a party wins a contract dispute in court and is awarded damages in dollars, he either accepts the dollars or gets nothing, so in that sense there is an implicit threat of force to accept dollars.

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