What Is Legal Tender?
Legal tender is anything recognized by law as a means to settle a public or private debt or meet a financial obligation, including tax payments, contracts, and legal fines or damages. The national currency is legal tender in practically every country. A creditor is legally obligated to accept legal tender toward repayment of a debt.
Key Takeaways
- Legal tender is the officially recognized money within a given political jurisdiction.
- Legal tender laws prevent the use of anything other than the existing official currency as money within the economy.
- Legal tender not only serves the economic functions of money but also allows for monetary policy and currency regulation.
The Fundamentals of Legal Tender
Legal tender is established by a statute that specifies what is to be used as legal tender and the authority responsible for issuing it—such as the U.S. Treasury in the United States or the Royal Canadian Mint in Canada.
In the U.S., the legal tender includes Federal Reserve notes and coins. Creditors must accept these as payment to settle debts. Private businesses, however, may refuse to accept some or all forms of cash—as long as a transaction has not occurred and debt has not been incurred.
Legal tender laws default and are designed to prevent the adoption of alternative forms of money within the economy. A check or a credit card transaction, for instance, is not legal tender; it is a means to eventually receive legal tender in return.
Cryptocurrencies are not widely accepted as money mainly because they lack legal tender status. Notably, El Salvador became the first country to accept Bitcoin as legal tender in June 2021.
Special cases include the attempted introduction of gold and silver coins as legal tender in Arizona, which was vetoed by the governor in 2013.
Special Considerations
Some currencies, such as the U.S. dollar and euro, are used as legal tender in countries without their own currency or those that prefer a more stable currency. For example, Ecuador adopted the U.S. dollar as legal tender in 2000. This practice is known as “dollarization” or currency substitution.
Legal tender can be categorized into two primary forms:
- Commodity Money: A government can officially approve market-determined commodities like gold as legal tender.
- Fiat Currency: A government can declare a valueless token or an adulterated commodity as legal tender, serving as the backbone of modern economies.
The Economic Functions of Legal Tender
Legal tender serves several essential purposes in an economy. It acts as:
- A medium of indirect exchange
- A unit of account
- A store of value
- A standard of deferred payment
Advocates for legal tender laws often argue that markets fail to produce the optimal type and quantity of money. Legal tender enhances monetary stability and reduces transaction costs. It enables flexibility in the money supply, eliminating the complications associated with multiple currencies.
Furthermore, legal tender facilitates monetary policy. It allows for currency manipulation, devaluation, and the issuance of fiduciary media to meet trade needs. Absent legal tender laws, monetary policies and the effective issuance of currency by banks would face significant challenges.
The Intersection of Cryptocurrency and Legal Tender
The rising popularity of online and cross-border shopping has heightened interest in alternatives like cryptocurrencies becoming legal tender. Despite global resistance, exceptions exist. El Salvador pioneered this movement by accepting Bitcoin as legal tender in 2021.
Many online platforms accept cryptocurrencies for transactions. However, due to their unofficial and often speculative status, cryptocurrencies mainly inhabit gray or black market economies.
In Venezuela, facing extreme hyperinflation, President Nicolas Madura mandated the use of a new electronic currency, the petro, as legal tender in 2018. Despite being backed by natural resources, the petro has yet to gain widespread use.
Similarly, the Republic of the Marshall Islands plans to introduce the sovereign cryptocurrency as legal tender, set to run alongside the existing use of the U.S. dollar.
Related Terms: fiat money, monetary policy, Federal Reserve, cryptocurrency, dollarization.
References
- Reuters. “In a world first, El Salvador makes bitcoin legal tender”.
- State of Arizona. “RE: Senate Bill 1439 (Legal Tender)”.
- The World Bank. “Dollarization and Semi-Dollarization in Ecuador”, Page 1.
- Usman W. Chohan. “Cryptocurrencies as Asset-Backed Instruments: The Venezuelan Petro”, Pages 2, 5.
- SOV. “What is SOV?”
