Paper Money and the Constitution

Dr. Edward Flaherty
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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