Home > Commodities, Currency, Economic Musings, Economics, Economy, Finance, Financial Crisis, Gold, Legal Tender, Money > Economic Musings X: Legal Tender – Legal or Tender or What?

Economic Musings X: Legal Tender – Legal or Tender or What?

After World War II when the German Reichsmark was discredited and people were starving they would travel from their city to the local farms …

… and pawn anything they still owned in exchange for some decent nourishing food. People would bring their grandfather clock or any heirloom that had survived pillaging and bombardment and the farmers grew rich and many a farm became rather exquisitely furnished with paintings and rugs in exchange for butter and pork. There also was a thriving “black market” in each city but in the last analysis it was nothing else but some intermediaries who had gone to the farms themselves and brought some food with them to swap against valuables thus sparing the citizen the time and stress of traveling to a farm himself.

(Statistical resources in our References section!)

There also was a currency: either you would swap whatever you got or you got hold either of cigarettes or … flint (chert) or fire stones. The latter were small and easy to carry much as coins would have been and everyone needed them for replacing the worn flint stone in their gasoline cigarette lighter.

All went well, after all, a black market is nothing but a market with the only exception that someone dislikes it because he hasn’t regulated it in the first place. That someone is called “the state” and whenever the state fails to safeguard (or should I say: tolerate) market mechanisms so that these market activities tend to be undertaken outside his remit he then calls that activity black. So selling pork at double the regulated price against flint stones in 1948 was illegal, selling slaves at whatever price at some stage in human history was legal despite the allusion to the colour “black”, while selling no pork in 1948 at the regulated price was also legal. Strange world.

Then the German currency was reformed in 1948 and all of a sudden stores began bulging with goods at “reasonable prices”. What was long dubbed the German “economic miracle” coincided with currency reform and many people and even economic historians to this day believe that currency reform played a major part.

Not so, I am afraid. The main reason, and another temporal coincidence, was the lifting of price controls. The salami was now sold in the “official” or “white market” instead of its “black counterpart” because not only did you have a common currency (that wasn’t the issue – you could still have swapped cigarettes for salami, couldn’t you?) but you were allowed to part with your salami at a price that you as a butcher thought was appropriate, not what your local price “overseer” had until then considered appropriate (or should I say expropriate? The poor guys – they must have been the first victims of economic reform and the first to be made redundant – or am I mistaken?).

Now, let’s assume you still had some cartons of cigarettes left (and you yourself were a non-smoker) – and you would have liked to get rid of your last bits of the old “currency” after the reform and swapped them for salami. But no, everyone wanted the new money like crazy.

That’s astonishing when you come to think of it – everyone was now crazy about some piece of paper and before that they were even choosy when it came to the brand of cigarettes you traded.

Brick money

That’s because the new money was declared “legal tender“.

And that requires some explanation because it is one of the cleverest scams that has ever been invented. Like the story of the “Wizard of Oz” – when you don’t take off your glasses for fear of being blinded you will always admire the emerald riches of legal tender for life (unless you suffer from civil war, hyperinflation or a de facto parallel currency like some countries do).

See, if I had a gun and you had a sheep and apart from the gun I also owned a, say, a brick and I would say to you:

State:    “Hey I want to buy that sheep from you” and you would say

Farmer: “Well I want something substantial in return, it’s a good sheep, I fed it well, it is well bred” etc.

State:    “Well”, I would say, “I give you this brick in return.”

Farmer:  “Oh, I don’t want a brick, I said I wanted something SUBSTANTIAL”.

State:     “Never mind, this brick is legal tender – it is worth a sheep, believe me!”

Farmer (in the face of the gun, a bit shaky): “Well, o.k., ah, but if I want to trade that brick for some lamb from my neighbour to raise another sheep, he mightn’t accept a brick as a lamb’s equivalent”

State:    “Don’t you worry – I assure you, if you tell him, the brick came from me he will”

Farmer:  “How can I be sure though?”

State (a bit aggravated by now): “Look, don’t you worry, if he doesn’t accept the brick, just you tell me and I’ll set him right – see this gun?”

Farmer (still sweating): “Ok, ok, but let’s assume he doesn’t accept the brick because he says it’s one of my own bricks – see there in the yard: that old barn I demolished last year – thousands of bricks, each worth a sheep” (smiles sheepishly).

State:     “Now, now, don’t give yourself airs you uneducated peasant – see this seal on my brick? You can’t forge a legal tender brick easily and if you do, oh my, you’ll spend some years behind bars counting the bricks in the cell wall.”

Ok, so, as modern contractual theory has it, sheep is swapped for brick, brick is swapped for lamb, probably brick is then swapped for insemination and so on and on the brick/sheep circuit continues. (Don’t forget, you can also deposit bricks at banks and get some brick receipts saving you the hassle to carry the physical brick; should you regularly deposit bricks by the truckload you can even get an American Excess, a Bricksa or Master Brick credit card and never need you worry about bricks again.)

Who needs legal tender legislation?

Actually, if I had gold in the bank and the bank had given me a depositary receipt for that gold and I went to you to buy a sheep the situation would be quite straightforward:

  • Either you would believe the bona fide depositary receipt because you believed in that bank’s “paper” or if not
  • you’d tell me: “Look, I like you personally, but see, I don’t know the issuer – would you mind bringing the sterling gold instead? After all, you get a real and no paper sheep from me, see?”

So either the seller would believe (credere means to believe in Latin) in the depositary receipt being a proxy, a representation of my “true gold” in the bank or he would insist in seeing the gold himself (“calling my bluff” as they would say in poker).

In either case my contractual counterpart and I would need no “legal tender” that both of us would “believe in” at point blank because if we didn’t we couldn’t do business at all. With gold, seeing is believing, with fiat money, believing is seeing.

Legal tender is a concept foreign to trading with valuables.

Currency at one time was a synonym for “marketable”. If the means of exchange are valuable your counterpart will gladly accept them in exchange of his wares and at an exchange rate that depends on both your mutual predilections and needs (two sheep when I’m hungry, a laxative when I’m overfed …). Such compulsory contractual stipulations become a necessity only when you have reason to doubt.

So I wonder: is (the concept of) legal tender legal?

  1. John
    2010-08-30 at 23:29

    Bernanke likes to remind everyone that he is an expert on the great depression and knows how to prevent it from happening again in the US. Apparently he is also an expert on Japan and its struggle with chronic deflation following its housing bubble in the 1980’s. In fact Bernanke wrote an article in 2000 titled “Japanese Monetary Policy: A Case of Self-Induced Paralysis,” where he goes on to lecture BOJ officials about what they could and should have done differently in order to to avoid a deflationary outcome. He goes on to postulate that the BOJ was not trying hard enough to stimulate the economy and that 0% interest rates are just one tool to beat deflation. The Fed Chairmen even goes so far as to assert that he knows how to escape a liquidity trap caused by 0% interest rates. The reason I bring this up is because it gives people a good idea of what Bernanke’s next move may be. The US is dangerously close to falling into the dreaded “liquidity trap” as deflation takes hold and monetary policy loses its effectiveness.

    Here are some of his suggestions to the BOJ:

    http://blackswaninsights.blogspot.com/2010/08/bernanke-explains-how-to-escape.html

  2. 2010-06-27 at 12:03

    Sabine: is there an English translation of the Bundesbank document you refer to?

  3. 2010-06-26 at 19:47

    Interesting bit of history, but I disagree with several points.

    1. You seem to assume that because the collapse of the Reichsmark gave rise to barter, that the latter constituted a black market. Not true. A black market is an illegal market. In 95% of countries 95% of the time there is nothing illegal about barter.

    2. As to Germany during and immediately post WWII, prices were regulated (as they were in the U.K.) thus black markets were possible and actually occurred.

    3. “That’s astonishing when you come to think of it – everyone was now crazy about some piece of paper and before that they were even choosy when it came to the brand of cigarettes you traded.” Not astonishing at all. Since the world began, ordinary people have greatly appreciated the value of a responsibly administered and stable currency: it offers huge advantages over barter.

    4. The whole business about legal tender is irrelevant. Have you ever heard of anyone being prosecuted for refusing to accept legal tender? It’s next to unknown. Much the most important characteristic of a currency is responsible
    administration. Once you have that, legal tender laws are just irrelevant.

    5. This is the most brilliant article on the history of money I have ever read:

    http://moslereconomics.com/mandatory-readings/what-is-money/

  4. 2010-04-16 at 13:38

    What an excellent question, CrisisMaven: is legal tender legal? Or also: who paid whom to draw up the laws: the definition of ‘legal tender’ for example or Article 104 of the Maastricht Treaty that allows only central banks to ‘print money’, or issue ‘legal tender’… But the Law of Money has come to determine what ‘law’ is, it seems…

    The Bundesbank has published a document called “Geld and Geldpolitik”, i.e. “Money and Money Politics”. And they now talk about “central bank money” as being the “legal tender” that banks can get from central banks… See http://bit.ly/bZUWZi

    I’m looking for people who’d be willing to investigate this document with a view to bringing it to the attention of the “Verfassungsgericht”. For central bank money can NEVER guarantee the basic human rights of the ciitzens of a democracy.

    Or is that too ‘manly’ as a way of facing our economic situation?

  1. 2010-04-23 at 19:08
  2. 2010-04-18 at 00:45
  3. 2010-04-17 at 08:15
  4. 2010-04-17 at 05:34
  5. 2010-04-16 at 09:32

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