Opportunities and Challenges of the U.S. Dollar as an Increasingly Global Currency: A Federal Reserve Perspective

Federal Reserve Bulletin, Sept, 2001 by Michael J. Lambert, Kristin D. Stanton

The ECI program allows selected depository institutions to hold currency in their vaults but to carry the inventory on the books of the Federal Reserve Bank of New York.(13) The Federal Reserve selects commercial banks to act as ECIs through a competitive bidding process. The ECIs receive deposits from depository institutions, sort them into old- and new-series notes, and further sort the new-series notes into bundles (1,000 notes) according to whether the notes are fit or unfit. The ECIs return the old-series and unfit notes to the Federal Reserve Bank of New York for destruction and recirculate fit new-series notes to the public. The Federal Reserve Bank of New York performs regular unannounced management reviews and operational audits to ensure that the ECIs comply with legally binding agreements to safeguard the integrity of the process.

IMPLICATIONS OF THE U.S. DOLLAR AS A GLOBAL CURRENCY

Increase in Interest Income

The asset counterpart to the Federal Reserve liability for currency in circulation takes the form of securities of the U.S. Treasury and government-approved enterprises (Treasury and federal agency securities represented 97.6 percent of the total collateral for currency in circulation at the end of 2000). Thus, the Federal Reserve issues non-interest-beating obligations (currency) and uses the proceeds to acquire interest-bearing assets. The excess of the earnings that the Federal Reserve accrues from these interest-bearing financial assets, above Federal Reserve System expenses and the provision of capital, is remitted annually to the Department of the Treasury. As currency in circulation has increased in response to growing demand for U.S. currency abroad, interest earnings have also increased (chart 5). For 2000, the securities counterpart to Federal Reserve notes earned $32.7 billion in interest income.

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Because the value of currency in circulation changes daily, the Federal Reserve Banks monitor and report changes in net payments to the Board. Net payments represent the difference between the amount of currency that the Reserve Banks pay to and receive from commercial banks. If net payments are positive, the Federal Reserve will typically purchase securities through open market operations in an amount equal to the net increase of currency in circulation to offset the monetary policy implications of the drain on depository institutions' balances held at the Reserve Banks. Similarly, if net payments are negative, the Federal Reserve will typically sell securities in an amount equal to the decrease of currency in circulation.

Counterfeiting Activity

The U.S. Secret Service was established in 1865 to suppress counterfeiting activity in the United States. During the free banking era (1837-1863), state bank notes became the chief form of paper currency, and each state-chartered bank could issue currency with its own design. Because there was neither a consistent design nor central control over currency issuance, this institutional arrangement created opportunities for counterfeiters to deceive the public. As a result, the Secret Service believes that during the free banking era, counterfeit currency circulated widely and may have made up as much as one-third of total currency in circulation.