Money is legal tender when creditors are legally obliged to accept it in payment of debts. The words “This note is legal tender for all debts, private and public,” appears on all Federal Reserve Notes, meaning that these notes are acceptable in payment of taxes or other obligations owed to the government and also that creditors must accept the notes in payment of all private debts.

In the expression legal tender the word tender means “offer,” as when an individual tenders his resignation. The term tender with reference to money arose out of actions of creditors against debtors in English courts. A debtor could “tender” to the creditor the amount he or she thought was owed to the creditor. If the creditor thought the sum tendered unacceptable, the debtor could deposit the sum with the court, which would decide if the tender met the debtor’s obligation.

The legal-tender quality of a unit of money can be restricted. The American colonies issued paper money that was acceptable for the payment of public debts, but not private debts. The colonial governments committed themselves to accepting the money in payment of taxes, but did not require private creditors to accept it in payment of debts. Currently in the United States the dime is legal tender for all debts up to $10.

English sovereigns arrogated to themselves the privilege of coining money and stipulated penalties for refusing to accept the king’s coinage at face value. Orders from the crown went so far as to require the acceptance of pennies that had been halved and demanded that anyone refusing to accept half pennies should be seized for contempt of the king’s majesty, imprisoned, and exposed to public ridicule in a pillory.

Although the English government threw the full weight of its sovereign power behind its coinage, disputes between creditors and debtors continued to raise questions, leaving with the courts the final authority for establishing the legal-tender quality of money. An important court case in 1601, The Case of Mixt Monies, set the legal-tender quality of money on firm footing when it demonstrated that creditors had to accept in payment for debts the money that was legal tender when the debt was paid, as opposed to the money that was legal tender when the debt was incurred.

The Constitution of the United States specifies that: “No state shall coin money; make anything but gold and silver coin a legal tender in payment of debts.” Prior to 1862 no paper money in the United States commanded the legal-tender status. Nevertheless the government often accepted bank notes and treasury notes in payment of taxes and public land sales, giving the paper money some legal-tender qualities. In 1862, amidst the fiscal crisis of the Civil War, the United States government issued paper money that was legal tender for all private debts, and many, but not all, public debts. The power of the government to issue legal-tender paper money was challenged in the courts, but the wartime crisis clouded the issue at first. When paper money continued to circulate after 1878 the legal-tender issue came before the Supreme Court, and in 1883 the Court ruled in favor of the power of the federal government to issue legal-tender paper money. In 1890 the federal government issued the first paper money that was legal tender in payment of all private debts and all payments owed to the government.

Economists have not always written approvingly of governments using their power to adjudicate disputes to render money legal tender. The famous economist John Stuart Mill wrote in his Principles of Political Economy (Book III, chapter vii):

Profligate governments having until a very modern period never scrupled for the sake of robbing their creditors to confer upon all other debtors a license to rob theirs by the shallow and impudent artifice of lowering the standard; that least covert of all modes of knavery, which consists in calling a shilling a pound that a debt of a hundred pounds may be canceled by the payment of one hundred shillings.

When governments become major debtors they have an incentive to change the standard to pay off the debts, and in the twentieth century governments have printed up legal-tender paper money to cancel large public debts, the post–World War I government of Germany being the most notorious case. Despite the latent possibility for abuse, governments worldwide issue legal-tender paper money, which poses no problems as long as the supply is restricted to noninflationary levels.