Why Using Gold And Silver As Legal Tender Is An Awful Idea

Includes: GLD, SLV
by: Robert Wagner

Arizona has just become the second state to allow gold and silver to be used as legal tender ... sort of. The reason I say "sort of" is because from this video, it is clear they haven't worked out all the bugs. The basis of this movement comes from a misunderstanding of Article 1 Section 10 of the U.S. Constitution which outlines the prohibitions of the states.

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

The clause wasn't intended to encourage the states to use gold and silver, it was intended to prevent them from repeating the mistakes made during the period when the colonies used the continental currency. During that era states were allowed to print their own money, eventually leading to an oversupply of currency making the continental currency essentially worthless. It basically was a complete disaster.

In 1792 the United States passed the Coinage Act effectively creating a gold standard, which was used to define the monetary system of the newly formed United States of America. It defined how the federal government would run the monetary system for the states. The following is an actual quote from the bill defining how to mint a golden eagle coin.

EAGLES--each to be of the value of ten dollars or units, and to contain two hundred and forty-seven grains and four eighths of a grain of pure, or two hundred and seventy grains of standard gold.

So by limiting the states to only using gold and silver COIN, and simultaneously prohibiting the states from COINING money, the federal government was able to establish their monetary system. The entire purpose of Article 1 Section 8, which grants Congress the power "To coin Money, regulate the Value thereof, and of foreign Coin," and Article 1 Section 10 which prohibits the states from "coining" money, and the federal government passing the Coinage Act is to prevent the states from doing exactly what Utah and Arizona are attempting to do.

The reason I say "attempting to do" is because what they are attempting to do won't work, and from the answers given in the video, I have a feeling even the state senator that sponsored the Arizona bill is awakening to that fact. The recent gold collapse, and gold being off over 20% from its peak, has pretty much forced the supporters of this movement to think through all the details, and what they are finding isn't pretty.

The fatal flaw in this concept is that states can't "coin" money, and what I mean by "coin" money is to take a weight of gold and stamp a value on it. Even if they did, it still wouldn't work, and I'll explain that later. Without the ability to "coin" money states are limited to using the commodity of gold as a currency, meaning that things would be priced in ounces of gold, not dollars and cents. The recent sharp drop in gold highlights why the system won't work.

Imagine going to a bank to take out a loan to buy a car. The loan is for $9,000 so the bank gives you about 5.7 oz of gold, when gold was trading about $1,580 just a few weeks ago. You go home, put the gold in a safe, and make plans to pick up the car on Monday April 15th, 2013. You show up at the car dealer with your 5.7 oz of gold, hand it to the car dealer, the car dealer types in the quote for gold and like a punch in the gut he asks you for another $900 and tells you gold is down 10% today. You had put a $200 deposit down, and now not only have you lost $900 on your loan which has to be paid back in U.S. dollars, you also lose your $200 deposit and are left without a car. That isn't an unlikely scenario, that just happened, and it would have been monumentally worse had you used a Bitcoin.

The second fatal flaw is when Sen. Chester Crandell points out that gold currently is a commodity, and isn't being used as legal tender. To make it legal tender, someone has to stamp a value on a weight of gold. Imagine if a few weeks ago they took 1 oz of gold and stamped $1,550 on it. If you owned a store would you accept it today? No. It makes no sense to stamp a value on a weight of gold unless you can fix the global price of gold, and that is what a gold standard is, a globally fixed price of gold. A one-world-currency so to speak. France takes one ounce and stamps a franc on it, Germany takes an ounce and stamps a mark of it, the U.S. takes an ounce and stamps a dollar on it, and so on and so on. States can't enter into treaties per Article 1 Section 10, and therefore can't fix the global price of gold. You simply can't have a gold and silver coin as legal tender if the price of gold and silver fluctuates on the global market. If you have a 1 oz gold coin with $1,550 stamped on it, and the price of gold goes to $2,000, people would simply melt it down and sell it for the metal. If the price of gold drops below $1,550, no one would accept the coin in a transaction, so you would be better off melting it down and converting it into a currency people would be willing to accept. The idea simply doesn't work unless the price of gold and silver are not allowed to fluctuate.

The third fatal flaw is exposed when Sen. Chester Crandell discusses how they removed the ability to pay taxes with gold and silver from the bill "because there seemed to be some concern with the department of revenues." The old saying goes "you can fool some of the people some of the time," but good luck fooling the IRS.

Once again, imagine the state paying all of its employees in U.S. dollars, and paying the federal government in U.S. dollars for its employee's federal taxes. Just by chance, the gold crash happened on April 15th, tax day. Ignoring the complexity of how you pay taxes with a commodity that is constantly changing in value, the facts are the state would have had a huge supply of gold going into April 15th, and by the end of the day would have been facing a 10% deficit. The IRS would be sending out agents to arrest the states for back taxes. The very fact that the states that support this movement ban paying taxes in gold and silver should be evidence enough that this is a very very bad idea. Because taxes can't be paid in gold and silver, no merchant in their right mind would ever accept gold or silver as a form of payment, unless they immediately converted it back into U.S. dollars, or ran a currency speculation business and wanted to speculate on the price of gold and silver.

Image a store accepting gold for a $1,550 item right before April 15th. Taxes would be owed on the full $1,550 and has to be paid in U.S. dollars. By the time the merchant paid the tax on April 15th, the gold was worth 10% less, but taxes are still owed on the full $1,550. If it was a small margin item, the merchant just took a loss. My hunch is that most merchants have little interest in being currency speculators, and will only accept the currency that is accepted for paying taxes.

The last fatal flaw to be covered is highlighted by the reporter who keeps asking why would people want to use gold, why not just use the U.S. dollar, what benefit is there? Those are the most basic and fundamental questions, and at least in my opinion, Sen. Chester Crandell wasn't able to answer them. He used the "its constitutional" argument that I debunked above, and he claims that they are going to study Utah as they implement their gold and silver tender law "and try to bypass any pitfalls that they've gone into." As the recent collapse of gold and silver and the Bitcoin prove beyond any reasonable doubt, monetary systems aren't playgrounds for ideological experiments. Most people don't have the interest, education, experience or skill to become currency speculators. That is why the simple U.S. dollar, with all is flaws, is still loved so much.

The belief that gold and silver are currencies or may one day become currencies is one of the main pillars holding up the value of gold/SPDR Gold Trust (NYSEARCA:GLD) and silver/iShares Silver Trust (NYSEARCA:SLV). The likely/predictable failure of the states attempting to implement a gold and silver legal tender law will likely shatter that belief and the support that it gives to gold and silver. States using gold and silver as legal tender is an awful idea, and simply won't work unless states can fix the global price of gold and silver and are willing to accept them as payment for taxes. The video that inspired this article highlights how even the people that have sponsored and passed these bills can't explain them, their benefits, the risk or even how they will be implemented. The reasoning they do use is deeply flawed, and is founded in a complete and utter misunderstanding of the U.S. Constitution's Article 1 Section 8 and Article 1 Section 10. The most important aspect of a currency is its stability, and gold and silver are anything but stable. States trying to implement gold and silver as legal tender will effectively make every citizen currency speculators, as they are forced to choose between the currency "options" available in the market. That simply provides unnecessary costs and complications with little to no benefits. If people want to use gold and silver as legal tender, all they have to do is buy the GLD with U.S. dollars, and when they want to buy something, convert their GLD back into U.S. dollars. Yes they would have to pay a transaction fee, but that is a small cost to pay to prevent the predictable train wreck that allowing gold and silver as legal tender would be.

In conclusion, As April 15th and the recent Bitcoin debacle have proven, tampering with the monetary system isn't only a very bad idea, it is financially dangerous as well. As this undeniable fact is finally recognized, the gold and silver as legal tender movement will most likely die, removing yet another support holding gold and silver up at these lofty levels. A possible/likely scenario would be for one of these bills to be repealed or never implemented, leading to the bill's supporters selling their gold in frustration, triggering yet another drop in gold and silver.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.