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Uses and Abuses of Gresham's Law
in the History of Money

by Robert Mundell
Nobel Prize for Economics, 1999

 

10. Overvalued Money and the Institution of Legal Tender

One important distinction between types of money is whether it is legal tender or not. Gresham's Law can come into play if two types of money are equivalent except in their role as legal tender. Very soon after coinage was discovered, rulers learned that the demand for money was different from the demand for the metal contained in the coins. Coinage began in steps that started when the state first put a stamp on a piece of metal signifying its purity, weight, and/or its value. It is possible that, initially, the value stated on the coin (its face value) was equal to the value of the metal it contained (its value by weight). But in the absence of a mechanism for ensuring that a coin had the same value qua metal that it had qua money -- free coinage was one mechanism -- the face value of the coin would become different from the coin's value as metal. A coin was said to be accepted ad talum (by count) if it was accepted at its face value; and it was said to be accepted ad pensum (by weight) when it was accepted for its value in metal.

When a currency must be accepted at its face value for payment of debt -- whatever its commodity value -- it is said to be legal tender. What is the meaning of this term? It should be noted first that it is a legal term. The institution of legal tender is a "term of avoidance" of the courtroom, in which a defendant might admit to borrowing money from his accuser, but plead "legal tender," namely, that at some previous time he physically had offered his creditor money which the law deemed acceptable for debt payments and had been refused. The court might not aid in the recovery of money once it had been turned down. The term legal tender is now used for a currency that cannot legally be refused in payment of debt. Other things equal, the attribute of legal tender would make one money "good" relative to another money.

There is a question issue whether the concept of legal tender is a term of private or public law. In his Money in the Law (1950), Nussbaum writes: "The question of the extent to which a creditor is under a duty to take "legal tender" in payment is undoubtedly one of private law. The endowment of coins or notes with the character of legal tender is, however, an act of sovereignty, hence of public law."(55) In other words the sovereign determines that which constitutes legal tender but its enforcement in the courts is a matter of private law.

The concept of legal tender suggests a distinction between two types of money: refusable money and non-refusable money, the latter of course being legal tender. In a typical country in the modern world, for example, currency is non-refusable money, cheques are refusable money, and coins are non-refusable money only up to a limit.

In recent centuries coins and notes may or may not have been non-refusable money. Bank of England notes (the Bank was created in 1694) had high reputation throughout the 18th century but were not made legal tender until 1812, when the government passed a law requiring sheriffs enforcing an order of the court to accept payment for the judgment creditor in bank notes. The notes, however, could not be pressed upon a creditor out of court, and if the creditor were willing to wait until the resumption of cash payments (which occurred only in 1821) he would be entitled to gold.(56) In 1833 the notes were made legal tender for as long as the bank maintained their convertibility, a formula that was allowed to persist throughout World War I. In 1928 the notes became unconditional legal tender and convertibility was abolished in 1931.(57)

The guinea, first coined in 1664, although a "current coin of the kingdom," was not made legal tender until 1717. The notes of John Law's Bank Générale, founded in 1716, were not legal tender but after the bank was transformed into a "Royal Bank" in 1718 the notes became legal tender.(58) The notes of the Banque de France, founded in 1800, became legal tender (apart from the emergency period of 1848-50) only in 1870. The notes of the Preussische Staatsbank, founded in 1775, were never legal tender and when it was replaced by the German Reichsbank in 1875, the notes of the latter were refusable until 1910.(59) Federal Reserve notes were not made legal tender until 1933.

In earlier times, it was generally true that the proclamation of a new coin implied its legal tender status at the face value. When a new coin was issued with the same name (e.g., penny, ecu, florin) but a lower weight or purity implying devaluation or debasement the question of justice arises between creditors and debtors. Should a debt be paid in the legal tender at the time of contract or at the time of repayment? This subject has given rise to endless controversy. Its relevance was made very apparent in the 1930s when Federal Reserve notes were made legal tender and the US dollar was devalued. The main issue was whether a gold clause in a contract would be legally binding (it was not).

Long ago the ancients had to deal with analogous questions. Argentum is a Latin word for both money and silver. Was a debt payable in argentum payable in silver or in legal tender? Cicer thought it was the latter:

"in our law we carry out the reasoning of Cicero, who held that argentum (in French, argent, or silver) meant money, and not metal. . . It follows that the efficacy of money is due to the value imposed on it by law, a fact deducible from its Greek name nomos and its Roman name nummus, both of which mean the Law, or that which is created by the law. It is the law that gives existence and efficacy to money and not the material of which the coins are made. Thus, says Paulus, to the Crown only (the Crown or the State being the living impersonation of the Law) belongs the right to confer denominational value upon money. Such value has often exceeded the value of the material two or three, or more, times, as was manifested in the leather issues of Frederick Barbarossa, the tin issues of Dionysius of Syracuse, the gun metal issues of the Sultan Othman (AD 1259-1326) during the wars against Persia, and in our own copper coins."(60)

That "argentum" meant money rather than just silver is amply proved by the following examples:

"argentariæ tabernæ, banker's shops (Livy); argentaria inopia, want of money (Plautus); argentarius, tresurer (Plautus); argentei sc. Nummi, or money (Pliny, xvi, 3); ubi argenti venas aurique sequuntur (Lucretius, vi, 808); cum argentum esset expositum in ædibus (Cicero); emunxi argento senes (Terrence); concisumargentum in titulos faciesue minutas (juvenal, xiv, 291; tenue argentum venæque secundæ (ibid., ix, 31)."(61)

The power of legal tender confers on its owner (the sovereign or government) a fiscal resource of the first magnitude. In the ancient world, as suggested in above quotation from Grimaudet, this power was used to overvalue money and reap the benefits of seigniorage, sometimes but not only in great emergencies.

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