I understand. But the point is really this: Even if legal tender is just probably legal tender, people will still accept it. Or if they know that can drive a few miles to the place that it is legal tender.

Paper money is one of the greatest creations ever. Only the demented genuflect to gold.

Phil, Thanks for the link and the excerpt. Having seen only Bank of England notes on my three visits to London, I am in no position to comment on the acceptability of Scottish banknotes in London. I gathered from John Kay that it was fairly routine, but maybe London cabbies are a more obliging group than the tradespeople frequented by John Lanchester.

Frank, I suspect that you know a lot more about MMT than I do, but my understanding is that making currency acceptable in payment of taxes, creates a real (i.e., non-monetary) demand (analogous to the real demand for gold). Without an independent real demand for an asset, so the argument goes, there cannot be a monetary demand for the asset.

Richard, Thanks for your elucidation

W. Peden, And yours.

Benjamin, But the point is that what constitutes legal tender in England and Scotland is not exactly clear, and yet money does seem to circulate there.

That is how a sovereign can create money, by printing it. If we have large unused capacity, and we are near deflation, then the sovereign can print more. It is a wonderful tool to have in a modern economy.

Is this hard to understand?

” Sterling does have a special legal function in Scotland; it’s just not as legal tender. The Scottish banks are limited in how much money they can create and this limitation comes from the BoE. ”

The limitation is only that they must hold on deposit at the BoE the same amount of sterling as the notes they create. They discovered early on that legally they only have to leave the sterling on deposit over the weekend. So they withdraw the sterling on a Monday and lend it into the money markets and redeposit on a Friday.

” The funny thing is that people have got it into their heads that our notes are legal tender here in England, mainly because we’ve been repeating it over and over again for about 300 years. ”

Yes, they are promissory notes that promise to pay the sterling equivalent.

The funny thing is that people have got it into their heads that our notes are legal tender here in England, mainly because we’ve been repeating it over and over again for about 300 years. The only occasion one is likely to hear the phrase “legal tender” is when there’s some controversy over a Scottish banknote (Clydesdale notes being the hardest to use).

Sayers’s 1960s book on banking described the Scottish and Ulster banks as being the “innermost parts of the Sterling zone”, which is a rather apposite way of describing the situation.

Legal tender laws have limited meaning in the UK. BoE notes must be accepted in England if offered in payment to settle debts. Scots Law does not recognise any paper money as legal tender. The courts developed their own understanding of legal tender by precedent when it comes to contracts. If a contract does not specify a currency for settlement, the court will assume sterling.

“A theory called chartalism, which sounds cranky, or modern monetary theory, which sounds better, argues that money derives its value from the willingness of governments to make payments and accept taxes in it.”

What modern monetary theory says is that the government levies taxes (cause) to create a demand for currency issued by the government (effect). In essence, government taxation and spending assures some level of money velocity within an economy. Interest rates are another way that the velocity of money is regulated within an economy.

Modern monetary theory does not argue that currency gets its value from the government’s ability to tax and spend. A government can tax and spend while destroying the value of it’s currency if it choses to spend that money on nonproductive or even destructive ventures – wars for instance.

The value of a currency relative to the goods and services it buys is strictly

Price Level ($ / good) = Debt ($ – All money begins as a debt) / Quantity of goods (goods) – aka the quantity theory of money

Money that is “printed” by the monetary authority has no effect on any economic variable until it is leant out – which is why I replace money supply M with debt D.

The change in price level (the inflation rate) introduces time as a variable in the equation:

Change in price level ($ / good * time period) = Debt ($) * Velocity (1 / time period) / Quantity of goods (goods)