What does ‘Legal Tender’ mean?

When talking about money, and more specifically about why we use certain things as money, the idea of legal tender often comes up. We all tend to use pieces of worthless metal, paper or cloth, or even entries in electronic databases as money worth far more than the things themselves. An intuitive explanation for this, and one I would have gone with in the past, is that it has something to do with the government designating certain things legal tender. I think people often have the idea that we all get payed in pounds because “pounds are legal tender.”

So I decided to find out what this phrase, legal tender, actually means. As it turns out it doesn’t mean very much and it has little baring in why we use and accept pounds.

In using the idea of legal tender in a country’s legal system authors of the legal system have to do the following:

1) Define what “legal tender” means

2) Establish which things are legal tender

3) Define how much those things are worth in the sovereign currency

The phrase “legal tender” is just that, a phrase. Any group of people can establish a legal framework that uses the phrase “legal tender” and then define it to mean whatever they want. Generally, however, it’s pragmatic to use the term to refer to the same basic idea. Usually “legal tender” means: “A thing that can never be refused as settlement of a debt in court”. Because “debt” is a legally defined concept debts are denominated in the legal system’s chosen currency, so by entering the court system you have established that the debt is measurable in that currency. So, if you are in court in the UK it is implicit that the debts being settled are measured in pounds. Things that are considered legal tender (according to 3) will also have a legally defined value in that currency.

You should also realise that this only refers to coins and banknotes, i.e. things, not pounds. You can have pounds in a bank account, and use those to settle debts in or out of court, that has nothing to do with legal tender because you never used any. Pounds aren’t legal tender, pound coins are. Pounds are what our legal system choses to denominate debts in, and by entering the legal system it seems a person implicitly agrees too that. I guess another way of looking at it is that within our legal system a debt is defined as a thing denominated in pounds. You could, of course, argue that there are other forms of debt, but you can’t usually take someone to court for owing you gratitude or a hug, and if you did it would map onto a case of damages or compensation in which the court would decide on a currency value, again, in pounds.

Putting this in an example: You are taken to court for not paying a debt of £100. The court demands you pay the debt. You pay by cheque. This has nothing to do with legal tender laws. You have payed a debt denominated in pounds in pounds. No things were exchanged. The banks just moved some numbers around in their accounts (and perhaps moved reserves between banks). Had you chosen to pay the debt with 100 pound coins, the court would have to accept that as payment as would the person to whom you owe the money. The debt would be settled. If the creditor agreed to accept payment in hugs, and you provided them, the case would be settled; no tender laws invoked.

In reality things are made complicated by there being many types of things that are legal tender, so the tender laws usually look more like this:

1) Define what “legal tender” means

2) Establish which things are legal tender for specific sized transactions.

A is legal tender for debts not exceeding x. B is legal tender for debts not exceeding y. C is legal tender for debts of any amount.

3) Define how much those things are worth in the sovereign currency

For example: In the UK 5p coins are only legal tender for debts not exceeding £5, while pound coins are legal tender for any amount.

Now, here’s the important point: None of this requires you to actually use legal tender. It just means that, in court, you can always use it to settle. Obviously, as mentioned, legal systems can define whatever rules they want, but we can look at actual examples of tender laws:

UK

From the Royal Mint’s website:

Legal tender has a very narrow and technical meaning in the settlement of debts. It means that a debtor cannot successfully be sued for non-payment if he pays into court in legal tender. It does not mean that any ordinary transaction has to take place in legal tender or only within the amount denominated by the legislation. Both parties are free to agree to accept any form of payment whether legal tender or otherwise according to their wishes. In order to comply with the very strict rules governing an actual legal tender it is necessary, for example, actually to offer the exact amount due because no change can be demanded.

US

From the US Treasury FAQ:

This statute [Coinage Act of 1965, Section 31 U.S.C. 5103] means that all United States money as identified above are a valid and legal offer of payment for debts when tendered to a creditor. There is, however, no Federal statute mandating that a private business, a person or an organization must accept currency or coins as for payment for goods and/or services. Private businesses are free to develop their own policies on whether or not to accept cash unless there is a State law which says otherwise. 

Australia

For the Reserve Bank of Australia FAQ:

However although transactions are to be in Australian currency unless otherwise agreed or specified, and Australian currency has legal tender status, Australian banknotes and coins do not necessarily have to be used in transactions and refusal to accept payment in legal tender banknotes and coins is not unlawful.

Canada

From the Bank of Canada‘s website:

“Legal tender” refers to the money approved for paying debts. […] This does not force anyone to accept cash because both parties must agree on the payment method. The fact that bank notes are legal tender does not mean that there is a legal obligation to accept them.

Japan

From the Bank of Japan‘s website:

Banknotes are a widely used payment instrument, especially for small-sized payments. The Law stipulates that banknotes shall be used for payment as legal tender, in other words, they are a legally defined payment instrument that should not be refused by any creditor in satisfaction of any debt.

If you open a shop in any of the above countries you can refuse business to anyone you want. The only grounds people have to complain is perhaps human rights (for example on the grounds of discrimination or something). You could simply refuse to accept payment in the sovereign currency. No transaction means no debt, no debt means that the tender laws are irrelevant. If I agree to ‘sell’ you a car, and we agree that you will ‘pay’ for it in gold, so long as the transaction happens as agreed then there is no debt, no basis for legal action and so tender laws just don’t apply.

Imagine for a second that the government wanted to use tender laws to make everyone use pounds, how exactly would they do that? If you and I swap a pencil for a pen, that is a transaction… would we have breached tender laws? What about payment-in-kind? Some people are payed less in salary because they get perks, those are non-legal-tender transactions, right? The point is it’s incomprehensible to think that the government could mandate use of sovereign currency because it’s not clear what transactions that would apply to and policing it would be impossible. Which probably is why they don’t.

In summary, when it comes to why people use pounds or dollars or yen, tender laws don’t give us much insight. You could argue they have increased usefulness because you can always use pounds to resolve debts in a legal setting… but that has nothing to do with tender laws, that’s simply the result of the particular legal system choosing what it defines debt to mean and how it is measured.

What about taxes?

Someone might argue that we have no choice but pay our tax bills in pounds. They might imagine it would be better if the government accepted gold or bitcoins or anything as payment of tax… the thing is, they kind of already do accept payment of tax in things other than legal tender. How? Public spending. The pounds you use to pay your taxes were issued by the government when it spent them into existence. It spent them by buying something, which was sold by someone in the private sector (or possibly by someone abroad). So you can sell products or services to the public sector, gain pounds, and then use those pounds to pay taxes. We all do this as a group all of the time. It’s just done at a macroscopic level. The government accepting X in payment of tax is financially exactly the same as the government buying X with pounds. In fact, this is literally the basis of our money system, it’s how all pounds come to be. The only reason the government doesn’t buy bitcoins is that they’re useless and there is no reason to.

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