The origin of the U.S. dollar as legal tender and its link to Depression

I have been very interested in the concept of legal tender of late because of the revelation this summer that the State of California was issuing I.O.U.’s to honour its debts instead of paying in U.S. Dollars, which are legal tender and I.O.U.’s from the U.S. government (see posts here and here). What I found most interesting about the California case was how the I.O.U.’s allowed a state experiencing a depression and prohibited from printing money to settle debts.  Given the similarities between California and Ireland, I felt this could be a model for that state (see post here).

The question was: how can a government without the levers of the money printing press use money as an escape-hatch in a depressionary environment? So to answer that question, I wanted to look at the origins of legal tender laws in the U.S.. When the United States was established, the U.S. Constitution outlined the basic framework through which government – both state and federal – could act on behalf of America’s citizens.  Nowhere in the U.S. Constitution was legal tender mentioned, and this is a bone of contention still amongst those who see the Federal Reserve as an illegitimate institution. Below, I want to outline a brief (and hopefully non-ideological) history of how the greenback became legal tender in the United States. I have some related comments at the end on Depressions and their lasting consequences on politics and history.

The Constitution

The Constitution mentions the word money in three sections (8, 9 and 10) of Article 1.  Below are the individual citations as they pertain to Congress acting on behalf of the federal government:

Section. 8. The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;

  • To borrow Money on the credit of the United States;
  • To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;
  • To raise and support Armies, but no Appropriation of Money to that Use shall be for a longer Term than two Years;

Section 9 is no longer applicable, but here it is.

Section. 9. The Migration or Importation of such Persons as any of the States now existing shall think proper to admit, shall not be prohibited by the Congress prior to the Year one thousand eight hundred and eight, but a Tax or duty may be imposed on such Importation, not exceeding ten dollars for each Person.

  • No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law; and a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time.

In Article 1, Section 10 of the Constitution, the authorities regarding money and taxation for individual states are outlined. It states:

Section. 10. No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

No State shall, without the Consent of the Congress, lay any Imposts or Duties on Imports or Exports, except what may be absolutely necessary for executing it’s inspection Laws; and the net Produce of all Duties and Imposts, laid by any State on Imports or Exports, shall be for the Use of the Treasury of the United States; and all such Laws shall be subject to the Revision and Controul of the Congress.

No State shall, without the Consent of Congress, lay any Duty of Tonnage, keep Troops, or Ships of War in time of Peace, enter into any Agreement or Compact with another State, or with a foreign Power, or engage in War, unless actually invaded, or in such imminent Danger as will not admit of delay.

You have probably noticed that nowhere in here was the term ‘legal tender’ used. Why? The intention was to allow anyone to issue coins and notes backed by gold or silver. In fact, foreign coins backed by gold and silver were accepted in the U.S. because 80 percent of money in circulation in the U.S. pre-1800 was foreign.

Centralisation or de-centralisation?

But, when the United States was created, there were factions. One faction led by Alexander Hamilton, a U.S. Constitution signatory and the first Treasury Secretary, favoured a strong central government.  The other, headed by Thomas Jefferson, favoured states’ rights and a more de-centralised government and was more in favour of the Articles of Confederation, which was the original constitution that created the United States. One reason the term Confederacy was used for government in the south during the Civil War was opposition to a strong central government, which was seen to favour money interests over farming interests and thus the North over the South.

(Hamilton is one of two non-Presidents on circulated paper money. His face is on the front of the ten-dollar bill.  Read the sordid details of his death at the hands of a sitting Vice President. The other non-President is Benjamin Franklin, on the face of the hundred-dollar bill. Since the 100 is the highest circulating U.S. bill, Benjamin Franklin has gained a certain notoriety as a result.)

As a result of the Civil War and the large costs associated therewith, the factions favouring more centralisation gained sway on money matters. Basically, the government was broke and needed to control the money supply in order to alleviate these debts. Heavy taxation was the only other alternative, not something likely to get one re-elected.  So Abraham Lincoln created the Legal Tender Act for the United States.

However, in 1870, the U.S. Supreme Court ruled these laws unconstitutional in a 4-3 decision in the case Hepburn v. Griswold.  What was peculiar about the ruling was that Salmon P. Chase was the chief justice presiding and voted against the greenback as legal tender. He was also Treasury Secretary at the time the legal tender law was enacted. He also happens to appear on the face of the 10,000 dollar bill, a denomination not in circulation today.

Chase was concerned that the legal tender law was legalizing theft through inflation (the government was printing so many greenbacks that they had plummeted in value vis-a-vis gold). In his opinion, Chase wrote:

We confess ourselves unable to perceive any solid distinction between such an Act and an Act compelling all citizens to accept, in satisfaction of all contracts for money, half or three-quarters or any other proportion less than the whole value actually due, according to their terms. It is difficult to conceive what act would take private property without process of law if such an act would not.

We are obliged to conclude that an Act making mere promises to pay dollars a legal tender in payment of debts previously contracted, is not a means appropriate, plainly adapted, really calculated to carry into effect any express power vested in Congress, that such an act is inconsistent with the spirit of the Constitution, and that it is prohibited by the Constitution.

However, President Ulysses S. Grant expanded the size of the court to the present nine, adding two members who favoured legal tender laws.  So, fifteen months after Hepburn, came Knox v. Lee. The  case decided in favour of the Legal Tender Act in a 5-4 decision. This is still the law of the land.

Knox v. Lee led indirectly to Jim Crow

I don’t have an opinion on this issue. You will see why below.  But I do have an opinion about the effects of the Legal Tender Act and Knox v. Lee.

First, the purpose of legal tender is to centralise the creation of money by creating monopoly control of the money printing press.  This might be done to reduce the chaos associated with allowing anyone to issue bank notes. But it also might be done to inflate and increase leverage for taxation purposes. There are competing ideas on this issue but it boils down to a centralisation versus de-centralisation/States’ Rights versus Federalist argument.

More crucially to me, the Legal Tender Act did lead to inflation after the Civil War and an artificial boom in Railroad investment created by this inflation. The inflation ended when Grant signed into law a bill restricting money growth by making greenbacks redeemable in gold. The boom turned bust in the Panic of 1873 when Jay Cooke & Company, a bank that was highly leveraged to the railroad industry, was brought down.  The period that followed was known as the Great Depression before 1929 ushered in another Depression.

The economic downturn created a backlash against the Republican Party of Grant, which was also the party of Reconstruction and black politicians in the south. As a result, the Democrats swept the 1874 Congressional elections and almost eked out a win in 1876 for the Presidency. To keep the Democrats happy, the Compromise of 1877 was made, which effectively ended Reconstruction and threw millions of southern blacks into a near-century of humiliation, disenfranchisement and subjugation known as Jim Crow. It was an abomination, the legacy of which stains America to this day.

I am no fan of States’ Rights as a result.  I see increased States’ Rights and de-centralisation as likely to lead to explicit measures of disenfranchisement. So when I look back to the history of legal tender laws, my point of view is very much biased by this fact.

What should also be clear from this Great Depression and the one after 1929 is that booms which turn into extraordinary busts lead to populist outcomes and the rise of populist leaders which have unpredictable negative long-term consequences.


A book that I like on this issue and Money and Banking more generally is called “A History of Money and Banking in the United States” by Murray Rothbard.  the view presented is a relatively anti-central bank, anti-legal tender one. Rothbard is a Libertarian of the Austrian School variety, so read his book keeping his biases in mind.

  1. Anonymous says

    Really, really a fantastic read. Thanks!

  2. Anonymous says

    Good read. Great historical analysis.

    However, the neo-Keynesian, centralized banking system under which Washington conducts its macroeconomic financial business is fatally flawed based on what you have said: that booms which turn into extraordinary busts lead to populist outcomes and the rise of populist leaders which have unpredictable negative long-term consequences.

    Neo-Keynesian centralized banking produces bubbles, which tear at the fabric of a country’s economy, and in the face of globalized world markets, at the fabric of the global economy. If banking is decentralized, there tends to be more “chaos” in the markets, but “chaos” here is merely a negatively shaded term for “creative destruction” – which is Smith’s “invisible hand”. When someone fails at business, he fails and is forced to restructure his methods and try again. When someone succeeds, he reaps the rewards.

    Neo-Keynesian economics contradicts this, as it puts the power in the hands of a centralized government-backed institution (The Federal Reserve), who can conduct macroeconomic policy in the interest of the Federal government. The drawback here is that the Federal government’s interests and the interests of the country are not always one and the same. This is the essence of the argument against the Fed, currently, that the Fed is conducting an agenda that is not in the best interest of all Americans in the long-term.

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