Legal tender
Money a creditor must accept in settlement of a debt by law — one of the props, alongside tax liabilities, that makes an intrinsically worthless token universally acceptable.
Also called: fiat currency, chartalism, fiduciary currency.
Legal tender law is narrower than people assume. It governs the settlement of debts already incurred; it does not oblige a shop to accept cash for a sandwich, and most countries let sellers set their own terms in advance.
The stronger prop is taxation. A government that demands payment in a particular unit creates continuous, non-optional demand for it — the chartalist argument that taxes drive money, and the reason a currency's acceptability tracks the reach of the state that issues it.
The rest is institutional confidence: an independent central bank, enforceable contracts, and a plausible expectation that the unit will still mean something next year. None of these is a physical backing, which is exactly why the arrangement is called fiduciary.
The mechanics
- Legal prop
- Statute makes the unit valid for settling debts within the jurisdiction.
- Fiscal prop
- Tax liabilities denominated in the unit create standing demand for it.
- Institutional prop
- Credibility of the issuer, and the expectation that it will be defended.
The common misreading
That fiat money is 'backed by nothing'. It is backed by an enforceable claim structure — tax obligations, courts, and a central bank — which is a different thing from being backed by a commodity.
Related terms
- Broad moneyMoney the public can actually spend — currency plus bank deposits and close substitutes — most of which is created by commercial banks when they lend.
- Monetary baseThe total of banknotes in circulation and commercial bank reserves — every form of money that is a direct liability of the central bank.
Primary sources
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