What Is Legal Tender?
Let me explain legal tender directly: it's anything recognized by law as a way to settle public or private debts or meet financial obligations, including taxes, contracts, and legal fines or damages. In almost every country, the national currency serves as legal tender, and creditors are legally required to accept it for repaying debts.
Key Takeaways
You should know that legal tender is the money or equivalent that a country or jurisdiction legally recognizes for all financial exchanges. It's typically the national currency everywhere. These laws prevent anything else from being used as money in the economy. Plus, legal tender enables monetary policy and currency manipulation.
Understanding Legal Tender
Legal tender gets established by statutes that specify what counts as money and which institution produces and issues it, like the U.S. Treasury in the United States or the Royal Canadian Mint in Canada.
In the U.S., recognized legal tender includes Federal Reserve notes and coins, and creditors must accept them when offered to pay off a debt. That said, private businesses can refuse some or all forms of cash if no transaction has happened yet and no debt exists, unless state law says otherwise.
These legal tender laws stop the widespread use of alternatives as money. For instance, a check or credit card swipe isn't legal tender; it's just a substitute that eventually leads to receiving legal tender.
Cryptocurrencies usually aren't accepted as money because they lack legal tender status. El Salvador was the first to accept Bitcoin as legal tender in June 2021. In Arizona, a bill to make gold and silver coins legal tender alongside U.S. currency got vetoed in May 2013.
Adoptions of the U.S. Dollar
Some currencies, like the U.S. dollar and euro, get used as legal tender in countries that don't issue their own or prefer a stable one over theirs. Ecuador adopted the U.S. dollar in 2000 after their sucre depreciated wildly, with $1 equaling 25,000 sucres.
Adopting the U.S. dollar as primary legal tender is called dollarization, though it's often just referred to as currency substitution.
Forms of Legal Tender
There are two main forms of legal tender. A government can ratify a market-determined commodity like gold and accept it for taxes and contracts, or it can declare a valueless token or adulterated commodity as legal tender, turning it into fiat currency.
Economic Function of Legal Tender
Legal tender serves key purposes in the economy: it acts as a medium of indirect exchange, unit of account, store of value, and standard for deferred payments.
Supporters of legal tender laws argue that markets don't produce the best money on their own, and legal tender reduces transaction costs by providing flexibility in money supply. A single currency eliminates costs from multiple competing ones, and imposing legal tender achieves that unity.
It also makes monetary policy possible, allowing issuers to manipulate, debase, or devalue currency for seigniorage and enabling banks to issue fiduciary media for trade needs.
Without these laws, Gresham's Law—where good money drives out bad—would complicate monetary policy, seigniorage, and currency issuance.
Cryptocurrency and Legal Tender
With rising cross-border and online shopping, there's demand for cryptocurrencies like Bitcoin to become legal tender, but official objections keep them unofficial in most places, including the U.S.
El Salvador led the way by accepting Bitcoin in June 2021. Many online services take cryptocurrencies legally, but they're mostly for gray markets or speculation due to lacking legal tender status.
Exceptions exist: Venezuela's President Maduro made the petro legal tender in 2018 amid hyperinflation, claiming it's backed by natural resources, but it hasn't circulated widely. The Republic of the Marshall Islands adopted the sovereign (SOV) cryptocurrency as legal tender alongside the U.S. dollar.
What Is Gresham's Law?
Gresham's Law states that bad money drives out good. If a gold penny and a tin penny both have the same legal tender value, people hoard the gold one and spend the tin, removing good money from circulation.
What Is Seigniorage?
Seigniorage is the value of money minus production costs. For a $100 bill costing 19.6 cents to make, seigniorage is $99.80.
What Is a U.S. Dollar Worth in 2024?
Inflation affects the dollar's value. Something costing $1 in 2010 would cost $1.44 in 2024 due to 44.4% cumulative inflation.
The Bottom Line
Legal tender is the recognized money within a country's borders, usually its national currency. Other forms aren't accepted for payments. This doesn't ban credit cards or checks in the U.S., as they're based on dollars, but you can't pay with pesos or cryptocurrencies unless specified.
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