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Those who hold that the constitution should be interpreted very strictly
believe the Federal Reserve System and paper money are unconstitutional.  Sharing
the interpretive philosophy of Thomas Jefferson, they argue that Congress has
only those powers which the constitution specifically enumerates.  If
the power is not explicitly granted, then the federal government simply does
not have it.  Therefore, the Federal Reserve is unconstitutional because
Congress does not have the specific power to create a central bank.  In
addition, the federal government’s power to create money — lawful money —
is limited only to minting gold or silver coins; paper currency is forbidden.  

The Constitutional Basis for Central Banking

First, the constitution grants the Congress the right to coin money and
to regulate its value.  It is not clear from the constitution or the
Federalist Papers what the authors meant by the term ‘value.’  Traditionally,
it has meant the weight and metallic content of the coin.  No one challenges
this interpretation.  On the other hand, the only relevant meaning of
‘value’ in the context of money is its value in trade, also known as its
purchasing power.  This a government cannot regulate merely by an act
of Congress.  The government’s only tool for regulating this latter
value is altering the money supply.

Second, Congress has the right to regulate interstate commerce.  Banking
and other financial services clearly involves interstate commerce as the
courts have come to define it.

Finally, and perhaps most importantly, Congress has the right to make any
law that is ‘necessary and proper’ for the execution of its enumerated powers
(Art. I, Sec. 8, Cl. 18).  A law creating a Bureau of the Mint, for
example, is necessary and proper for the Congress to exercise its right to
coin money.  A similar argument may justify a central bank.  It
facilitates the expansion and contraction of the money supply and it serves
as means to regulate the banking industry.

Is this a reasonable use of the necessary and proper clause?  I do
not know, but a test of its meaning came early.  The history of central
banking in the United States does not begin with the Federal Reserve.  The
Bank of the United States received its charter in 1791 from the U.S. Congress
and Washington signed it.  Secretary of State Alexander Hamilton designed
the Bank’s charter by modeling it after the Bank of England, the British
central bank.  Secretary of State Thomas Jefferson believed the Bank
was unconstitutional because it was an unauthorized extension of federal
power.  Congress, Jefferson argued, possessed only delegated powers
that were specifically enumerated in the constitution.  The only possible
source of authority to charter the Bank, Jefferson believed, was in the necessary
and proper clause.  However, he cautioned that if the clause could be
interpreted so broadly in this case, then there was no real limit to what
Congress could do.2

Hamilton conceded that the constitution was silent on banking.  He
asserted, however, that Congress clearly had the power to tax, to borrow
money, and to regulate interstate and foreign commerce. Would it be reasonable
for Congress to charter a corporation to assist in carrying out these powers?
He argued that the necessary and proper clause gave Congress implied powers
— the power to enact any law that is necessary to execute its specific powers.
A “necessary” law in this context Hamilton did not take to mean one that
was absolutely indispensable. Instead, he argued that it meant a law that
was “needful, requisite, incidental, useful, or conducive to” the primary
Congressional power which it supported. Then Hamilton offered a proposed
rule of discretion: “Does the proposed measure abridge a pre-existing right
of any State or of any individual?” (Dunne, 19).  If not, then it probably
is constitutionally proper on these grounds.  Hamilton’s arguments carried
the day and convinced Washington.

The Supreme Court had its say on the matter in McCulloch v. Maryland (1819).  It
voted 9-0 to uphold the Second Bank of the United States as constitutional.  The
Court argued with the doctrine of implied powers, stating that to be ‘necessary
and proper’ the Bank needed only to be useful in helping the government meet
its responsibilities in maintaining the public credit and regulating the
money supply. Chief Justice Marshall wrote, “After the most deliberate consideration,
it is the unanimous and decided opinion of this court that the act to incorporate
the Bank of the United States is a law made in pursuance of the Constitution,
and is part of the supreme law of the land” (Hixson, 117). The Court affirmed
this opinion in the 1824 case Osborn v. Bank of the United States (Ibid,
14).

Therefore, the historical legal precedent exists for Congress’ power to
create a central bank.  It formed the Federal Reserve system in 1913
to perform many of the same functions as its predecessors.  As before,
the courts have agreed that a central bank, and the Federal Reserve in particular,
is constitutional.  

The Constitutional Basis for Paper Money

Even if the Federal Reserve is a constitutionally proper institution, what
of paper money?  The federal government has issued many forms and denominations
of paper currency since 1812.  It first made paper a legal tender in
1862.  Does not the constitution require the Congress to coin money,
not to print it?  Is this not what the authors of the constitution intended?  Perhaps,
but it’s not an air-tight issue.   S.P. Breckenridge wrote in Legal
Tender of the significant disagreements the delegates to the constitutional
convention had over the issue, and even over the interpretation of the wording
that they eventually adopted.

Prior to the constitutional convention in the summer of 1787, the States
exercised their sovereign powers over monetary matters.  Most States
had issued their own forms of paper money, typically called ‘bills of credit’ at
the time, and had declared some foreign coins as a legal tender.  By ‘legal
tender’ we mean a form of money which a government specifies may be used
to settle debts and to pay taxes due to it.  During the Revolutionary
War many States issued paper money to excess.  The Congress of the Articles
of Confederation had also relied heavily on using paper money to fund its
war expenditures.  The States had also declared various forms of paper
currency, including  the Congress’ emissions, a legal tender.  Severe
price inflation was the necessary result of this over-indulgence in paper,
and by the time the constitutional convention convened paper money had many
enemies.

The primary foes of paper money were commercial and banking interests.  When
a lender agrees to fund a loan, he charges a rate of interest which, among
other factors, includes a premium for any expected loss in the purchasing
power of the principal during the life of the loan.  If the price level
is expected to rise, say, five percent then the lender will insist on an
interest of at least that amount.  If in actuality the price level increases
eight percent, then the lender stands to lose as much as three percent of
his principal.  If a government has the power to issue paper money,
then the potential abuse of this power increases the probability of an unexpected
inflation.  Commercial concerns also were generally against allowing
paper, and for similar reasons.  The sour inflationary experience of
the previous decades made the business climate less stable than it might
otherwise be with a constitutionally guaranteed gold or silver monetary standard.  In
addition, such a standard would protect the integrity of commercial contracts
that specified fixed payments in specie.  These interests at the convention
therefore had two objectives: To forbid both the States and the federal government
from issuing bills of credit — the common term for paper money at the time
— and to base the monetary system on gold or silver.

Paper money was not without its partisans, however.  Agricultural interests
and debtors were fond of paper money, as well as Ben Franklin, and for many
of the same reasons.  The losses a lender is likely to suffer at the
hands of a paper-induced inflation are exactly offset by the gains of the
borrower.  The debtor would then be able to repay a fixed debt in less
valuable currency.  Farmers also generally favored paper money because
it tended to create an economic climate of rising commodity prices relative
to other goods, thereby increasing their real income.  Their monetary
goal at the convention was to give the government the right to issue bills
of credit or, at the very least, not to deny it the power.

Charles Pinckney of South Carolina produced a draft of a constitution that
had two interesting features for our purposes.  From Art. VII. Sec.
1 of his draft we read “The legislature of the United States shall have power … (4)
To coin money … (5) To regulate the value of foreign coin … (8) To borrow
money and emit bills on the credit of the United States …”  Also we
find in Article XII: “No state shall coin money.”  We further read in
Article XIII: “No state, without the consent of the legislature of the United
States, shall emit bills of credit, or make anything but specie a tender
in payment of debts.”  We can glean some indication of the Founders’ intent
concerning paper money from the debate on the matter in Madison’s notes on
the convention.  What follows below is an excerpt of those notes on
this debate:  

MR. GOUVERNEUR MORRIS [PA.] moved to strike out “and emit bills
on the credit of the United States.”  If the United States had credit
such bills would be unnecessary; if they had not, unjust and useless.

MR. BUTLER [S.C.] seconds the motion.

The fundamental theory on which the Founders created the U.S. constitution
is of a government of limited powers.  The federal government would have
only those powers specifically enumerated and those reasonably necessary to
enact them.  If a power is not expressly given to it, then it is denied.  What
Robert Morris of Pennsylvania seeks to do with the above motion is to deny
the federal government the specific right to issue paper money.  The discussion
continued:  

MR. MADISON [Va.] Will it not be sufficient to prohibit making
them a tender? This will remove the temptation to emit them with unjust views;
and promissory notes in that shape may in some emergencies be best.

MR. GOUVERNEUR MORRIS: Striking out the words will still leave room
for the notes of a responsible minister, which will do all the good without
the mischief.  The moneyed interests will oppose the plan of government
if paper emissions be not prohibited.

MR. GORHAM [Mass.] had doubts on the subject.  Congress, he thought,
would not have the power unless it was expressed.  Though he had
a mortal hatred to paper money, yet, as he could not foresee all emergencies,
he was unwilling to tie the hands of the legislature.  He observed
the late war could not have been carried on had such a prohibition existed.

Gorham’s thoughts on this are key to interpreting how the Founders would eventually
resolve this issue.  The Revolutionary War was financed to a great extent
on paper money the Continental Congress and later the Congress of the Articles
of Confederation had issued.  The Congress had no taxing authority of
its own and the newly independent States were unwilling to contribute any significant
funds of their own for the war effort.  The Congress, with limited credit,
was therefore left to emitting paper money.  Although its over-issuance
was largely responsible for the severe inflation of the time, it was also clear
to the Founders and to later historians the States could not have funded their
effort in any other way.  The personal financial losses many of the delegates
suffered at the hands of the paper money did much to alienate them from the
medium, but it did not erase from their memory the acknowledgment of its financial
contribution to their independence.  Gorham, like others at the convention,
disliked paper, but were hesitant in denying forever the government’s ability
to use it.  Madison’s notes continued:  

MR. MERCER [Md.] was a friend to paper money, though in the present
state and temper of America he should neither propose nor approve of such
a measure.  He      was consequently opposed
to a prohibition of it altogether.  It will stamp suspicion on the government
to deny it discretion on this point.  It was impolitic also to excite
the opposition of all those who were friends to paper money.  The people
of property would be sure to be on the side of the plan, and it was impolitic
to purchase their further attachment with the loss of the opposite class
of citizens.

MR. ELLSWORTH [Conn.] thought this a favorable moment to shut and bar
the door against paper money.  The mischiefs of the various experiments
which been made were now fresh in the public mind, and had excited the
disgust of all the respectable part of America.  By withholding the
power from the new government, more friends of influence would be gained
to it than by almost anything else.  Paper money can in no case be
necessary.  Give the government credit, and other resources will offer.  The
power may do harm, never good.

MR. RANDOLPH [Va.], notwithstanding his antipathy to paper money, could
not agree to strike out the words, as he could not foresee all the occasions
that might arise.  

Here in a microcosm is the debate on whether to deny the federal government
the right to issue paper money.  Mercer and Ellsworth clearly represented
the agricultural and commercial interests, respectively, and their positions
are understandable within this context.  Randolph, however, took the middle
ground, wondering whether it was wise to tie the hands of future legislatures.

Eventually, the convention voted 9-2 to strike the clause, thereby denying
the federal government the specific power to emit bills of credit.  The
relevant sections of the constitution eventually approved read: Art. I. Sec.
8.: “The Congress … shall have power … (2) to borrow money on the credit
of the United States … (5) To coin money, regulate the value thereof, and
of foreign coin, and fix the standard weight and measures.”  Art. II.
Sec 10.: “No state shall coin money nor emit bills of credit nor make anything
but gold and silver coin a legal tender in payment of debts …”

These clauses have several implications relevant to the question of whether
today’s paper money is constitutional.  Among the lesser effects for
our purposes is that it removed from the States their previous sovereign
power to coin money or to emit paper money.  It also restricted what
they could declare a legal tender.  The question, though, is whether
the Congress may legally issue paper money.  Some argue that it was
the Founders’ intent to bar the door to paper money permanently and the vote
to strike the bills of credit clause from Pinckney’s draft is evidence of
this intent.  This may be a hasty interpretation, however.

Although several members of the convention wanted to deny paper money to
the federal government and believed the act of striking the ‘bills of credit’
clause accomplished the task, not all delegates shared either this intent
or this interpretation.  Several  members, as shown above, were
either friends of paper money or did not want to tie the hands of the Congress
for all time.  The interpretation of their action varies widely.  Mason
believed that if the power was not expressly given, it was denied.  As
far as he was concerned, the Congress could not authorize paper money.  Morris,
though, believed it to be permissible for a ‘responsible minister.’  Madison,
who cast the deciding vote in the Virginia delegation to strike the clause,
still viewed it as legal provided the notes were safe and proper.  Madison
wrote, “Nothing very definite can be inferred from this record” as to the
views of the convention on this matter.  As President, Madison approved
of a $36 million non-legal tender paper money issue to help finance the War
of 1812.  His actions seem to have spoken louder than his words.  Luther
Martin, a delegate from Maryland, explained his views to the Maryland legislature
and stated:

Against this motion we urged that it would be improper to deprive
the Congress of      that power; that it would be
a novelty unprecedented to establish a government which should not have such
authority; that it would be impossible to look forward     into
futurity so far as to decide that events might not happen that should render
the exercise of such a power absolutely necessary; and that we doubted whether
if a war should take place it would be possible for this country to defend
itself without resort to paper credit, in which case there would be a necessity
of becoming a prey to our enemies or violating the constitution of our government;
and that, considering that our government would be principally in the hands
of the wealthy, there could be little reason to fear an abuse of the power
by an unnecessary or injurous exercise of it.

It is clear the intent of the Founders was to prohibit the States from issuing
paper money.  It is not clear whether the same intent applied to the Congress.  Wrote
Breckenridge, “the clause granting to Congress the power to emit bills was
stricken out, and no prohibition was laid.  Silence as to that was maintained;
and all that can be said as to the interpretation of that silence is that,
although there was a strong and well-nigh universal dread of paper issues,
there was a stronger dread of too narrowly limiting the powers of the new legislature;
and that there was neither a very definite nor a unanimous opinion as to the
effect of striking out the clause, or as to the extent of the power granted
(p.84).”  It appears the Founders, whether intentionally or not, left
the paper money issue to be settled by future generations.  

Recent Federal Court Rulings on the Federal Reserve and
Paper Money

Below are some recent court rulings on the issues of the Federal Reserve
and paper money.

U.S. v. Rickman, 638 F.2d 182, C.A.Kan. 1980:

Federal Reserve Notes in which the defendant, charged with failure
to file federal income tax returns, was paid were lawful money within the
meaning of the United States Constitution. 26
USCA §7203
; USCA Const. Art. 1, §8, cl. 5.

U.S. v. Wangrund, 533 F.2d 495; C.A.Cal. 1976

The statute establishing Federal Reserve Notes as legal tender
for all debts, public and private, including taxes, is within the constitutional
authority of Congress; thus the defendant could not overturn his conviction
on two counts of wilful failure to make an income tax return on the theory
that he did not receive money since checks he received as compensation for
his services could be cashed only for Federal Reserve Notes which were not
redeemable in specie. 26
USCA §61
, §7203;
USCA Const. art. 1, §8; Coinage Act of 1965, §102; 31
USCA §392
.

Nixon v. Individual Head of St. Joseph Mortgage Company, 615 F.Supp. 890,
affirmed 787 F.2d 596. D.C.Ind. 1985.

Federal Reserve notes are legal tender.

Ginter v. Southern, 611 F.2d 1226, certiorari denied 100 S.Ct 2946, 446
US 967, 64 L.E.d.2d 827. C.A.Ark. 1979.

Tax protestor’s claims concerning the constitutionality of the
Federal Reserve System, Internal Revenue Code and establishment of tax court
were so frivolous as not to require discussion and detail. USCA Const. Amends.
5, 13; 28 USCA §1346; 26
USCA §6532
, 26
USCA §7422
.

U.S. v. Schmitz, 542 F.2d 782 certiorari denied 97 S.Ct. 1134, 429 US 1105,
51 L.Ed.2d 556. C.A.Cal. 1976.

Federal Reserve Notes constitute legal tender and are taxable dollars.
USCA Const. Art. 1, §10.

Milam v. U.S., 524 F.2d 629. C.A.Cal. 1974.

The statute which delegates to the Federal Reserve System the power
to issue circulating notes for money borrowed and the power to define the
quality and force of those notes as currency is valid … Although golden
eagles, double eagles, and silver dollars were lovely to look at and delightful
to hold, the holder of a $50 Federal Reserve Bank Note, although entitled
to redeem his note, was not entitled to do so in precious metal. Federal
Reserve Act, §16, 12
USCA §411
; Coinage Act of 1965, §102, 31
USCA §392
.

Moreover, the paper money issue is an irrelevant one.  If we replace
each all paper that has “one dollar” printed on it with a coin that has “one
dollar” stamped on it, what will we gain?  We willl have achieved compliance
with the literal words of the constitution at the expense of a convenient
and popular form of money.  

Gold and Silver Coin

It is also sometimes argued that the constitution permits the minting only
of gold or silver coins.  This is a misinterpretation, as a federal
court makes clear in  U.S. v. Rifen, 577 F.2d 1111. C.A.Mo. 1978:

The United States Constitution prohibits states from declaring
legal tender anything other than gold or silver but does not limit Congress’
power to declare what shall be legal tender for all debts … Federal Reserve
Notes are taxable dollars. Coinage Act of 1965, §102, 31
USCA §392
; USCA Const. Art. 1, §10.

This point is made further in Nixon v. Phillipoff, 615 F.Supp. 890, affirmed
787 F.2d 596. D.C.Ind. 1985:

The provision of the Constitution [USCA Const Art. 1, §8,
cl. 5] which gives Congress the right to coin money, and regulate the value
thereof, gives Congress exclusive ability to determine what will be legal
tender throughout the country … The provision of the Constitution [USCA
Const. Art. 1, §10, cl. 1] which mandates that no state shall make anything
but gold or silver coin tender in payment of debts acts only to remove from
states inherent soverign power to declare currency, thus leaving Congress
as the sole  declarant of what constitutes legal tender; the provision
does not require states to accept only gold and silver as tender … Federal
Reserve Notes are legal tender for any debt or public charge … Using or
accepting Federal Reserve Notes as payment for state court filing fees was
completely proper under the Constitution. USCA Const. Art. 1, §8, cl.
5; 31 USCA §5103.

The court made the point again somewhat humourously in Foret v. Wilson, 725
F.2d 400. C.A.La. 1984:

Gold and silver coin do not constitute the only legal tender by
the United States; thus, the appellant, who bid $2.80 in silver dimes on
a foreclosed property requiring a minimum bid of $80,000 under Louisiana
law, was not entitled to the deed to the property.

Are Gold and Silver Practical Metals for Coins?

We could replace all our paper money with coins containing the appropriate
amount of a precious metal.  Gone would be the $1 Federal Reserve Note,
and in its place a coin with $1 stamped on it.  Apparently, this would
make the paper money opponents happy.  Or would it?  As it turns
out, the amount of gold that would need to be in a $1 coin would be so tiny
it would barely be there at all.

In the summer of 1999, the price of gold is about $250/oz.  Therefore,
a $1 coin would need 1/250ths ounce of gold in it; that is to say, it would
contain 0.4% gold and 99.6% base metals.  A quarter-dollar would have
0.1% gold and 99.9% base metals.  A $20 coin would have 8.0% gold and
92% base metals.  If any more gold than that were included, then it
would pay to melt the coins and sell the gold, and then we’d be without a
physical medium of exchange.

Silver has the same problem.  The price of silver is about $5/oz.,
so we could mint a $5 coin containing 100% silver.  A $1 coin would
have 20% silver.  A quarter would have about 5% silver and 95% base
metals.  Could anyone honestly tell the difference between the quarter
we have now and one with 5% silver?    

References:

Breckenridge, S.P., Legal Tender, N.Y.: Greenwood Press, 1903, 1969.

Dunne, Gerald T., Monetary Decisions of the Supreme Court, Rutgers Univ.
Press, 1960.

Hixson, William F., Triumph of the Bankers: Money and Banking in the Eighteenth
and Nineteenth Centuries, Praeger, 1993.

Footnotes:

1. I have no formal legal training and do not consider myself
a constitutional scholar.

2. Then, curiously, in the memorandum in which he articulated
his thoughts on this matter, Jefferson advised that if the President felt
that the pros and cons of constitutionality seemed about equal, then out
of respect to the Congress which passed the legislation the President could
sign it (Dunne, p. 17-19).  

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