What Is Lawful Money?

Lawful money is any form of currency issued by the United States Treasury and not the Federal Reserve System. It includes gold and silver coins, Treasury notes, and Treasury bonds. Lawful money stands in contrast to fiat money, in which the government assigns value although it has no intrinsic value of its own and is not backed by reserves. Fiat money includes legal tender such as paper money, checks, drafts, and banknotes.

Lawful money is also known as "specie," which means "in actual form."

Key Takeaways

  • Lawful money is currency issued by the United States Treasury, such as gold and silver coins, Treasury notes, and Treasury bonds.
  • Fiat money, which consists of paper money and checks, is not lawful money but is considered legal tender.
  • The difference arises from the U.S. Constitution, which specifies gold and silver as the legal form of tender for debts, hence the varied interpretation since new forms of payments came into circulation.
  • The Federal Reserve Act of 1913 gave the Federal Reserve the right to issue Federal Reserve Notes, which are backed by the U.S. government and are redeemed in lawful money, but did not specify what lawful money meant.
  • In 1933 Congress amended the Federal Reserve Act to include all U.S. coins and currency as legal tender, to avoid any confusion about what type of money is legally permissible.

Understanding Lawful Money

Oddly enough, the dollar bills that we carry around in our wallets are not considered lawful money. The notation on the bottom of a U.S. dollar bill reads "Legal Tender for All Debts, Public and Private," and is issued by the U.S. Federal Reserve, not the U.S. Treasury.

Legal tender can be exchanged for an equivalent amount of lawful money, but macro-effects such as inflation can change the value of fiat money. Lawful money is said to be the most direct form of ownership, but for purposes of practicality, it has little use in direct transactions between parties.

History of Lawful Money

The Federal Reserve Act of 1913, which established the Federal Reserve System and authorizes it to issue Federal Reserve notes, states that “[Federal Reserve notes] shall be obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and for all taxes, customs, and other public dues. They shall be redeemed in lawful money on demand at the Treasury Department of the United States, in the city of Washington, District of Columbia, or at any Federal Reserve bank."

However, the Act did not explicitly define what lawful money meant. Since some currencies that could be used by national banking associations as "lawful money reserves" were not considered legal tender, Congress amended the Federal Reserve Act in 1933 to include all U.S. coins and currency as legal tender for all purposes.

The 1933 amendment extended the power of legal tender to all types of money, creating dissension on whether paper money and reserves of the Federal Reserve bank are lawful money. While some argue that Federal Reserve notes are lawful money, others tend to disagree.

Confusion Over Lawful Money

Since the US Constitution states “no state shall make any thing but gold and silver coin a tender in payment of debts,” some believe that this is the definition of lawful money and, thus, any payment medium other than gold or silver is not considered lawful money. In effect, the primary meaning of lawful money is legal tender, but a broader interpretation is frequently applied in certain contexts.

Because no legal definition of lawful money was ever provided, the term has led to a lot of confusion, primarily in legal aspects. For all intents and purposes, lawful money should mean legal tender but is not always the case. This has caused a lot of confusion for students of law and banking.

Professionals believe that Congress should pass a simple statute stating what lawful money is, ensuring it includes all forms of U.S. currency, particularly since the use of gold and silver is not a regular occurrence anymore.

Lawful money is separate from the classification of money, which is broken down as M0, M1, M2, and M3. The classifications incorporate all of the money used in the U.S. economy.