Extinguishing Debt

Extinguishing Debt

Thomas Allen

    Commodity money, such as gold and silver, is real money. Real money is a medium of exchange that extinguishes debt and other financial obligations. Credit money, such bank notes, government notes, gold certificates, checks, and bills of exchange, is not real money. Credit money does not extinguish debt or other financial obligations. It merely discharges the debt or obligation by passing it to another person or entity.
    Although checks, bank notes, government notes, and certificates, are used as mediums of exchange, they are not real money themselves. Only real money can extinguish debt. They are promises to pay money. Under today’s monetary system, the issuer has no intentions of keeping that promise. Therefore, under today’s monetary system only national bankruptcy via hyperinflation or repudiation can extinguish debts.
    When a person buys groceries, he can pay with full-weight gold coins (assuming the gold standard) or with a check or bank note. If he pays with gold coins, no further obligation exists. The grocer has received something that is no one else’s obligation, gold coins. If the buyer pays with a check or bank notes, the buyer’s obligation to the grocer has been discharged. However, it has not been extinguished. The grocer has received a promise to transfer gold to the grocer. The obligation is not extinguished until the grocer presents the bank notes or check to the bank that issued them, and the bank converts the check or bank notes to gold coins.
    Likewise, with debt, a borrower extinguishes the debt when he pays with gold coins. He has paid the lender with money that is no one else’s obligation. If he pays with bank notes or check, he has merely discharged the debt. It has not been extinguished. It has been transferred to the bank. The debt is not extinguished until the lender presents the check or bank notes to the issuing bank, and the bank converts them to gold coins.
    If the buyer or borrower uses governmentally issued notes, like U.S. notes or gold certificates, he has discharged his financial obligation to the grocer or debt to the lender. However, the financial obligation or debt has not been extinguished. It has been passed to the government. The obligation or debt is not extinguished until the government redeems its notes and certificates in gold, that is, commodity money.
    In the United States between 1879 and 1933, gold certificates (first issued in 1882), bank notes, and government notes, which were called U.S. notes and nicknamed greenbacks, were redeemable in gold on demand. (U.S. notes were legal-tender; the other two were not.) If a debtor used one of these forms of credit money to pay his debt, he discharged his debt, but he did not extinguish it. If he paid with bank notes, the obligation was transferred to the issuing bank. If he paid with gold certificates or U.S. notes, he transferred the obligation to the U.S. government. The debt was not extinguished until the bank note, certificate, or greenback was converted to gold. (This conversion permanently retired the bank note and gold certificate. However, it did not permanently retire U.S. notes. The Secretary of the Treasury had a statutory obligation to reissue U.S. notes after they were redeemed.)
    Under today’s paper monetary system, debts and other financial obligations are never extinguished. They are merely passed from one person to another and eventually become an obligation of the government or its central bank. (In the U.S. all debts become obligations of the U.S. government as federal reserve notes are by law obligations of the U.S. government. Since the Bank of England is a department of the British government, its bank notes are obligations of the British government.) Nevertheless, these debts will eventually be extinguished.
    Under a fiat monetary system, debts may be extinguished in several ways. First and most likely, is to inflate the debt away by destroying the value of the money and pushing it to zero. (The Continental, assignat, the Hungarian inflation of 1945-46, and, more recently, the Zimbabwe dollar are examples of this phenomenon.) However, this approached is often forestalled by replacing one fiat paper money with another fiat paper money. (This has occurred often in Latin American countries.) Even countries that have destroyed their paper money with hyperinflation usually choose to replace the old paper money with new paper money. Another way debt can be extinguished under a fiat paper money system is for the issuing country to die as the result of war. (That is what happened to debts denominated in Confederate dollars. When the Confederate States of America died as the result of the War for Southern Independents, their money, which was not legal tender, also died. Along with the death of the money was the extinction of debts denominated in Confederate dollars.) Countries may also extinguish debt by repudiating them as monarchs of the Middle Ages occasionally did. Another approach is to return to a commodity monetary system, such as the gold standard, where paper money is convertible in the monetary commodity. (Great Britain took this approach some years after the Napoleonic Wars when it returned to the gold standard. The United States returned to the gold standard in 1879 after leaving it in 1861.)
    Thus, debt can be extinguished in several ways. One is by reputation. Another is by the death of the currency from inflation or war. The best and least painful way to extinguish debts is with commodity money, such as gold. That is, by paying debt with money that is no one else’s obligations.
    Commodity money, such as gold and silver, extinguishes debts and other financial obligations. Credit money, such as checks, bank notes, government notes, and bills of exchanges, cannot extinguish debts and other financial obligations. They discharge debts and financial obligation by transferring them to another.
    (Bills of exchange were another form of credit money used under the gold standard. A retailer accepted a bill of exchange from a wholesaler. The wholesaler could use the bill to discharge his debt to the manufacturer. When the wholesaler paid with the bill, he was no longer in debt to the manufacturer. He had discharged his debt to the manufacturer with a debt, the bill, which promised to pay gold by a specific date. The wholesaler paid his debt by passing it to the retailer. The debt still existed. Now the retailer had the obligation to extinguish the debt by paying gold to the manufacturer instead of to the wholesaler. When the retailer paid the bill in gold to the manufacturer, he extinguished the debt. The financial obligations represented by the bill, and the bill itself, ceased to exist.)

Copyright © 2016 by Thomas Coley Allen.

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