How A Mistake By The Supreme Court Allowed Fiat Money In the US

   Here is a very interesting research paper from the Bank of Japan which discusses how the US got off the bi-metallic system and evolved into a purely fiat-money system. The real culprit according to the author is not FDR or Nixon, but the US Supreme Court which failed to properly distinguish between fiscal and monetary policy when deciding the constitutionality of Greenbacks (notes issued by the government to finance the Civil war) and Legal Tender Laws in the 1860's. The Court affirmed the legality based on an incorrect interpretation of the Constitution which allows Congress to borrow money. The Court argued that issuing fiat currency was within the government's power to borrow. These important decisions were vital to destroying America's metallic based monetary system and the purchasing power of the dollar.  The author concludes that "that monetary arrangements in the U.S. have departed sharply from those specified by the Constitution, and that the change has been based in crucial ways on invalid reasoning."

 Here is an excerpt from the article:

4. Supreme Court Decisions and Future Monetary Policy

But what, one might well ask, does all of this have to do with current and future monetary policy arrangements? My answer is that the Supreme Court arguments in favor of Greenback constitutionality relied to a substantial extent on a crucial confusion between monetary and fiscal policy. In particular, note that “the power to borrow money” is a fiscal, not a monetary, provision. Specifically, it gives Congress the right to borrow—to sell government debt to the public—an activity that does not necessarily entail any change in the outstanding stock of money. “Borrowing” and “lending” are terms that pertain to fiscal actions, not monetary actions; for when the Treasury sells or purchases bonds rather than raising or lowering taxes (in order to finance increased or decreased government expenditures) there is no necessary or implied change in the nation’s quantity (stock) of high-powered money—and no change in the private sector’s holdings when the borrowed funds are immediately spent on (e.g., military) supplies and wages, as was the case in 1862.

But the reasoning expounded by Supreme Court justices in two crucial cases did not recognize this distinction. Instead, they argued as if the quoted power (“to borrow
money”) would justify the issue of legal-tender fiat money. These cases were Knox v.
Lee (in 1870) and Julliard v. Greenman (in 1884). In addition, the arguments made by congressmen in 1861 in favor of the Greenback issue and by minority members of the
Supreme Court in the Hepburn v. Griswold case (Hepburn, p. 257), also involved this confusion. In sum, it is my argument that the failure to distinguish clearly between monetary and fiscal policy actions was a major contributing factor to the Supreme Court decisions that made possible the alteration of the U.S. monetary standard from a metallicmoney to a fiat-money system, a change of truly fundamental and momentous proportion.

Of course this change was not completed until much later, as convertibility of paper money into gold was maintained from 1879 until 1933 and some remaining elements of a metallic system until 1971, as is well known. But the legal tender cases were necessary preludes to the later steps in the process of de-metallization; without them, subsequent actions and judicial rulings could have been very different from those that actually transpired.

Thus the failure of legislators and justices to recognize the basic distinction between monetary and fiscal policy played a central role in the fundamental and momentous historical change, from metallic to fiat regimes, in U.S. monetary arrangements.

   What is interesting is that this paper was written by a researcher at the Bank of Japan. You rarely see a central bank commission an article which questions the legality of fiat money.

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  1. Thanks for the good insight--will the Supreme Court ever get it right? It's doubtful since it's been on the wrong side since Marbury versus Madison right through to today.

    1. The banks are the cause of all the funny money that we see floating sround the world today.