Myth #3: The Federal Reserve Act and paper money are unconstitutional.  Gold and silver coins are the only constitutional forms of money.

Table of Contents:

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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