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Legal Tender

Updated on April 29, 2024
Article byNanditha Saravanakumar
Reviewed byDheeraj Vaidya, CFA, FRM

Legal tender is a mode of payment that a country legalizes for its citizens and businesses to use for making any transactions within the jurisdiction. It usually includes coins and banknotes issued by the government. It, thus, serves as an official currency, authorized and controlled by a nation’s central bank or a nation’s treasury.

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Legal tender makes it possible to send money abroad, settle debts, and make public and private payments. Additionally, it enforces the use of a single currency and permits flexibility in the money supply, both of which reduce transaction costs. Additionally, it permits the government and central bank to alter their monetary policies to stabilize the economy

Key Takeaways

  • A legal tender in economics refers to the officially authorized and legally accepted mode of payment in a country, usually its currency.
  • The law authorizes using coins and banknotes for tax payments and debt settlements. It serves as storage of value, a unit of account, and a standard of deferred payments.
  • Although checks, cards, cryptocurrencies, and digital money can nevertheless be used for transactions, they do not qualify as a form of legal tender.
  • ·It is different from fiat money, as the government does not always legally authorize the latter. Furthermore, the value of fiat money depends on the citizens’ perceptions, not on any physical commodities like gold, etc.

A legal tender is nothing but a country’s official currency. It is the legally accepted form of payment monitored by the central bank or other financial institutions in a country. It ensures a flexible money supply. However, multiple competing currencies have high transactional costs.

The government recognizes its national currency as a legal tender for its citizens and businesses.  Therefore, there is no legal justification for people or companies to decline to accept it. For example, the United States Treasury and the Federal Reserve control the issuance and authorization of coins and printed dollar bills in the U.S. Similarly, the Reserve Bank of Australia issues the Australian dollar, which comprises bank notes and coins.

An individual or entity must accept any payment made using the legal tender money as part of a contract or transaction. However, there are some exceptions. For example, if the government has passed any bans or restrictions against it, the transaction does not occur even if the payment is made.

Legally authorized tenders only include coins and currency notes issued by the government. Checks, credit swipes, cards, and cryptocurrencies are payment alternatives to legal hard cash. However, using these is legal as, in the end, the beneficiaries convert them to the official currency.

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One can use cash to make payments up to a fixed limit. Beyond it, they can demand another tender. For example, in some countries, payment made using coins is limited to a fixed amount. Therefore, one cannot expect to pay a massive amount using only coins. It, thus, implies limited legal tender money. 

On the other hand, unlimited legal tender accepts money as a medium of payment, up to any amount. Usually, beneficiaries offer currency notes as payment for clearing due of any size in such cases. 

A given coin/currency must fulfill two conditions simultaneously to gain acceptance as legally authorized tender:

  1. It must be fiat money for purchasing goods and services or settling debts
  2. It must be legally valid for payments of all national debts and transactions

While the citizens and businesses perceive fiat money’s worth, Fiat money will no longer hold value if people lose faith in it.

Here are the prime differences between fiat money and legal tender money:

Fiat Money  Legal Tender Money
Government can issue it and make it legal for repayments of debt.The government officially and legally authorizes it.
It does not have any intrinsic value.It has a value of its own.
No physical commodity/metallic reserve backs it. So, it is not convertible into standard money on demand.In most cases, a commodity such as gold backs it.
Holders cannot redeem it.It is redeemable.

Examples of both fiat and legal tender money are the U.S. dollar. In fiat money, also known as inconvertible paper money, ‘Fiat’ means government order or command of the sovereign. However, it is no longer a legal tender because, legally, the government banned it from transactions.

G-Sec, T-Bills, shares, bonds, demand drafts, checks, ATM, cards, casino coins, bitcoins, and filmstar currency are not fiat money. Therefore, they are not legally authorized tenders. On the other hand, commemorative coins are fiat money but not legally authorized tender unless notified to be used. 

Examples

Here are legal tender examples of some countries:

Example #1

In 1862, the U.S. government passed the Legal Tender Act, which authorized printed dollar notes as the official mode of payment in the country. The government gave this act to finance the civil war. However, it is of prime importance today, as the USD is the most widely used currency in the world. Cent coins, too, are legally accepted in the U.S.

The U.S. Treasury and the Federal Reserve oversee the supply and control of the coins and dollar bills in the U.S. The existing denominations include 1¢, 5¢, 10¢, 25¢, 50¢ and $1 coins; and $1, $2, $5, $10, $20, $50 and $100 notes. 

Example #2

The case of El Salvador would be one of the best legal tender examples in this context. The country became the first to adopt a cryptocurrency as its legally accepted tender. In June 2021, El Salvador adopted Bitcoin as the official mode of payment and transactions. Earlier, it was using the USD. 

However, recently the country’s financial situation has worsened. El Salvador President NayibBukele’s excessive support for Bitcoin is being heavily criticized by many. Despite the poor performance of the cryptocurrency last month, the President bought 500 Bitcoins additionally, thus defaulting on the country’s debt payments. Overall, the situation looks gloomy for El Salvador by adopting Bitcoin as the country’s tender.  

A legally accepted tender plays various roles, such as a store of value, a measure of value, or a unit of account in an economy. Here are some more facts highlighting its importance:

Importance of Legal Tender 

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  1. Medium Of Exchange – The tender acts as a medium or mode of payment and transactions in a country. An official medium is necessary to facilitate economic activities. 
  2. Uniformity – There are many currencies worldwide. The unrestricted usage of multiple currencies in a marketplace has many demerits. Therefore, a common currency for a country based on its economy, culture, and requirements will be appropriate. Otherwise, the whole system would work like barter – exchanging apples for rice.
  3. Greater Financial Control – A country’s government and the financial authority will be able to oversee the supply and issue of the tender. It helps them keep track of illegally printed notes and black money. The government will also be able to analyze the level of commercial activity.
  4. Serves Economy – The legally accepted tender has the potential to propel the economy by controlling money supply, inflation, and consumer spending, through the government’s monetary policies.
  5. Protects Monetary Interests Of Citizens And Businesses – The tender ascertains the value of the goods and services bought and sold. For example, if a car costs $50,000, this price includes the cost of labor and raw materials. Hence, every economic activity is attached to an appropriate value. 

Frequently Asked Questions (FAQs)

What is legal tender in the U.K.?

The legally authorized tender in the United Kingdom is the Pound Sterling. However, contrary to popular belief, the Euro is not an official currency in the U.K. 

What is limited legal tender money?

A limited legal tender is one in which the payment using the particular tender is limited to a certain amount. For instance, coins in some countries are limited tenders. That is, beyond a defined limit, beneficiaries should make the payment using another tender like currency notes unless otherwise stated by the recipient. 

Which countries have cryptocurrency as legal tender?

El Salvador became the first nation to have a cryptocurrency as its legally authorized tender in June 2021, when it adopted Bitcoin officially. Other countries that have followed suit include Venezuela (Petro), the Central African Republic (Bitcoin), and the Republic of Marshall Islands (Sovereign).

When did silver threepence cease to be legal tender?

Silver threepence (British Coins) ceased to be legal tender in1970. It was first issued in 1551 in silver for King of England  Edward the VI. It was one of the most recognized coins of the pre-decimal English coinage system.

This has been a guide to Legal Tender & its meaning. We explain limited and unlimited legal tender, its examples, importance, & differences from fiat money. You can learn more about accounting from the following articles –

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