Friday, February 20, 2009

Money in Crisis: Revisiting the Legal Tender Cases

Frank Pasquale

Despairing at the stimulus package, some voices on the right have launched a first principles attack on the borrowing it entails. In the Wall Street Journal, Judy Shelton says "let's go back to the gold standard," claiming that "Fiat money -- i.e., currency with no intrinsic worth that government has decreed legal tender -- loses its value when government creates more than can be absorbed by the productive real economy." Thomas E. Woods at the contrarian The American Conservative notes the intellectual roots of today's gold bugs:

The libertarian and conservative think tanks that liberally invoke the names of Austrian School economists like F.A. Hayek have tended to ignore these men’s opposition to central banking, a position too politically incorrect even for those who pride themselves on their willingness to defend unpopular positions.

Many of these thinkers worry about an apocalyptic hyperinflation sparked by a Fed gone wild. Like predictions of depression, such predictions of monetary instability may be a self-fulfilling prophecy, as worries about the funding of the stimulus mount.

The standard progressive response to these worries is to dismiss them as fringe thought--as Paul Krugman might say, the worry now is deflation, not inflation. But John Chung's fascinating article Money as Simulacrum: The Legal Nature and Reality of Money puts the new concerns about the dollar in a historical light. By examining the reasoning of the Supreme Court's "legal tender cases," which examined "whether Congress has the power to make paper a good tender in payment of debts,” Chung draws some disturbing conclusions about present monetary controversies.

American history buffs are probably aware of the great conflicts over the gold standard in the US, especially William Jennings Bryan's classic Cross of Gold speech of 1896. Even as the concept of fiat money percolated into US monetary policy, conservatives denounced it. Chung highlights Justice Field's dissent in Juilliard v. Greenman, where Field asked "why should there be any restraint upon unlimited appropriations by the government for all imaginary schemes of public improvement, if the printing-press can furnish the money that is needed for them?" But the panic of 1907 and subsequent creation of the Federal Reserve put the US on the long road toward a repudiation of the gold standard. Since 1933, U.S. money has been backed by nothing but itself, as this language from the Treasury Department acknowledges:

Federal Reserve notes are not redeemable in gold, silver or any other commodity, and receive no backing by anything. This has been the case since 1933. The notes have no value for themselves, but for what they will buy. In another sense, because they are legal tender, Federal Reserve notes are ‘backed’ by all the goods and services in the economy.

It's hard to imagine a different course of events from our vantage point; why should the supply of money in an economy be tied to anything as arbitrary as the supply of gold? Given advances in chemistry and nanotechnology, precious metals themselves may someday be as easy to generate as dollars.

But the new gold bugs think the monetary system should be a matter of choice, and complain that law disadvantages their preferred means of doing business. Here's Shelton:

Legal tender laws currently favor government-issued money, putting private contracts in gold or silver at a distinct disadvantage. Contracts denominated in Federal Reserve notes are enforced by the courts, whereas contracts denominated in gold are not. Gold purchases are subject to taxes, both sales and capital gains. And while the Constitution specifies that only commodity standards are lawful -- "No state shall coin money, emit bills of credit, or make anything but gold and silver coin a tender in payment of debts" (Art. I, Sec. 10) -- it is fiat money that enjoys legal tender status and its protections.

Now is the time to challenge the exclusive monopoly of Federal Reserve notes as currency. Buyers and sellers, by mutual consent, should have access to an alternate means for settling accounts; they should be able to do business using a monetary unit of account defined in terms of gold. The existence of parallel currencies operating side-by-side on an equal legal footing would make it clear whether people had more confidence in fiat money or money redeemable in gold. If the gold-based system is preferred, it means that people fully understand that the purpose of money is to facilitate commerce, not to camouflage fiscal mismanagement.

Commenting on the proposed "Indiana Honest Money Act," which would, "if enacted, allow citizens the option of paying in or receiving back gold, silver or the equivalent electronic receipt as an alternative to Federal Reserve notes," Shelton claims that there is "a growing feeling in the heartland that we need to go back to sound money." Like Thomas Frank's Kansans, Indiana populists of today have apparently reversed course from their Bryanite forbears.

Of course, such a parallel banking system may turn out to be little more in practice than a creative way of avoiding taxes. Other authors have predicted that "The computer revolution . . . will subvert and destroy the nation-state as globalized cybercommerce, lubricated by cybercurrency, drastically limits governments' powers to tax." Such yearning for a new gold standard may look like a hedge against reckless state spending, but sets in motion the very processes it claims to fear by setting up exchanges that can avoid the tax burden of the real economy.

Furthermore, the problem of monetary stability can't be solved by gold. Shelton may be upset that, as Chung puts it, "Paper money, formerly the sign of the real (gold), has become the real." Yet even if a gold standard were restored to its "rightful place," gold's value again would be a product of belief, not any fixed intrinsic worth its atoms have. People now tend to treat gold as a "safe" alternative to money or stocks, but that perception is only based on predictions about what will function as a medium of exchange or store of value in the future. Chung observes that "Money is now a pure abstraction with its own self-referential value and reality, whose creation is no longer constrained by a reference to anything else," but the same would likely apply to gold once it was accepted as payment for debts. It's turtles all the way down.

Ultimately, just as the market is preceded by law, money's value hinges on its ability to value past actions and to exert force over the future. Money is legitimate to the extent it is distributed wisely and fairly; money is valuable to the extent it gives power. Given the near-record levels of US inequality reached in recent years, money's legitimacy may be declining. But anyone who observes the Paulson-Geithner reaction to the financial crisis can't help but appreciate its power: particularly as expressed in campaign contributions, and the range of the "thinkable" in the press.

Yet at some point even this power might fade. Chung wisely focuses on today's bizarre concentrations of wealth as an indication of the "death of reference" in our monetary system and its replacement with "a total relativity." He notes that "In 2007, the average amount of annual compensation for the top 25 highest paid hedge fund managers was $892-million." Even before the financial crisis, could anyone believe that any of these individuals made over 17,800 times the economic contribution of, say, a plumber making $50,000 per year? As Brad Delong has calculated, "not even the richest of the pre-Civil War southern slaveholders disposed of" the property in the hands of today's billionaires.

While the new gold standard advocates panic over government spending and efforts to shore up the banking system, perhaps they should consider exactly what present distributions of money entail. If the $892,000,000 per-year hedge fund manager and the $50,000-a-year plumber were to come up to a store at the end of a year of work, and bid for its contents, does it really make sense to give the former 17,839/17,840 of its goods, and the latter 1/17,840 of them? If money is starting to seem unreal, maybe America's fractal inequality has more to do with it than government's efforts to remedy its effects.

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