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The Department of the Treasury The Use and Counterfeiting of United States Currency Abroad, Part 3
Contents
PrefaceThe Department of the Treasury wishes to thank the Congress for its insight in the passage of PL104‑132, the Antiterrorism and Effective Death Penalty Act of 1996, which initiated this study. The Congressional mandate contained in PL 104‑132, Section 807 has enabled Treasury, the Federal Reserve, and the Department of Homeland Security to work more effectively in the international arena. In addition to the information gathered during the study, the program has helped establish contacts and networks for gathering information. Over the course of the last ten years, the direct knowledge of the use of U.S. currency abroad and the opportunity to assess the counterfeiting threat allowed the U.S. government to make informed decisions regarding the public education program for new currency designs, the distribution of U.S. currency abroad, and the most effective ways to thwart counterfeiting activity. As established in the act, this is the final report, which summarizes what was learned during trips to countries around the world that use U.S. currency. Residents of many countries outside the United States use U.S. banknotes as a store of value and as a medium of exchange. A substantial share of U.S. banknotes in circulation has been held abroad for several decades. Today, we estimate that nearly 60 percent of all U.S. banknotes in circulation, or about $450 billion of the $760 billion in circulation as of December 2005, is now held abroad. Because banknotes can move undetected across borders, data and methods to estimate such holdings are by necessity indirect and based on simplifying assumptions that must be updated periodically to keep these assessments as accurate as possible based on the information received. It is important that we keep these channels assessable to the U.S. Treasury, the Federal Reserve, and the U.S. Secret Service to augment the data gathering process, which is a vital part of keeping us abreast of demand trends and counterfeit activity. During the course of this ten-year study, the introduction of new design currency was an important issue. The knowledge obtained through this study was used by Treasury to develop international public education programs, which have facilitated smooth introductions of new currency designs. In addition, the Secret Service obtained valuable information through the study and will continue to draw upon information arising from the study to evaluate its internal strategy. U.S. dollars (USD) are often found in countries with volatile political and economic conditions. Accordingly, much of the growth in international U.S. currency usage during the past two decades has occurred in Latin America and in formerly socialist countries. In many of these economies, to the extent that citizens and small businesses continue to face unstable local currencies as well as underdeveloped banking and payment systems, accumulating savings and making transactions in local currencies is difficult. As a result, many residents of countries facing unstable or crisis conditions opt to conduct saving and transaction functions in other currencies, often USD. The external circulation of USD provides benefits and presents challenges to U.S. taxpayers as well as USD holders abroad. The billions of U.S. banknotes held outside the United States represent a windfall to U.S. taxpayers because of the seigniorage revenues generated by the added currency demand, and they serve as a useful asset for USD users outside the United States who have no other liquid and stable assets available.1 However, the presence of USD in areas outside the direct jurisdictional reach of the U.S. Secret Service makes them a potential target for counterfeiters, who range from organized professionals with sophisticated printing facilities and considerable skill to amateurs with access only to copying machines or inexpensive computer printers. Counterfeiting is primarily carried out for economic gain but may also be associated with other crimes, including drug trafficking and illicit arms dealing. USD users abroad also face challenges in obtaining USD and information about USD, and in dealing with suspected counterfeits that are typically more simply resolved with their locale's legal tender. This study reaches five major conclusions about the counterfeiting of U.S. currency. First, the average incidence of counterfeit U.S. currency passing is generally low both inside and outside the United States, notwithstanding occasional large seizures of uncirculated counterfeits.2 Second, foreign banks and law enforcement agencies are eager to develop expertise, technology, and communication links with the U.S. Secret Service to detect and suppress counterfeiting activity. Third, the International Currency Awareness Program (ICAP) has helped expand and strengthen working relationships between the U.S. Secret Service and foreign financial and law enforcement organizations, which has allowed for improved investigations and training. Fourth, ICAP teams have found that one factor that both increases concern about counterfeiting and hampers enforcement is a lack of legal authority for banks and cash handlers to confiscate suspected or actual counterfeit U.S. currency. Fifth, ICAP teams have consistently found that the U.S. Secret Service U.S. Dollars Counterfeit Note Search website (USDOLLARS) established in 1999 has been extremely effective in aiding banks and cash handlers, their customers, and law enforcement in tracking and identifying counterfeit notes. This study is the last in a series of three reports and provides updates to the first two reports, which were issued in 2000 and 2003. Much of the information presented in the earlier reports remains valid today. As in the previous reports, some figures and information were available only from discussions with various governmental and commercial-sector officials; data gathered in such a way are inherently fragmentary. However, the models used in the reports to estimate the share of currency held abroad and the quantity of counterfeits in circulation generate results that are consistent with the information provided by the teams' interlocutors. This report was prepared for the Secretary of the Treasury under the direction of the Advanced Counterfeit Deterrence Steering Committee by staff at the Federal Reserve, U.S. Treasury Departmental Offices, and the U.S. Secret Service. Contributing to this report were Jon Cameron, Project Director for the International Currency Awareness Program, U.S. Department of the Treasury; Jacqueline Marengo, Assistant to the Special Agent in Charge, Criminal Investigative Division, U.S. Secret Service; Ruth Judson, Economist, Division of Monetary Affairs, Board of Governors of the Federal Reserve System; and Jeffrey Pruiksma, Cash Officer, International Cash Department, Federal Reserve Bank of New York. Executive SummaryIntroduction
Findings Regarding the International Use of U.S. Currency
The Introduction of the Series 1996 New Currency Design (NCD) and the Series 2004 New Color of Money Design (NCM)
Findings Regarding the International Counterfeiting of U.S. Currency
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1 Introduction1.1 BackgroundThis report is the last of three on the results of a long-term study of the use and counterfeiting of U.S. currency abroad undertaken as required by Section 807 of PL 104‑132, the Antiterrorism and Effective Death Penalty Act of 1996. As defined in the act, the Secretary of the Treasury, in consultation with the Advanced Counterfeit Deterrence Steering Committee (ACD), provides program direction for the study. The study program, currently known as the International Currency Awareness Program (ICAP), is an extension of an earlier effort known as the Joint International Study Team (JIST). JIST preceded the introduction of the new currency design (NCD) $100 note in March 1996 and was an effort on the part of the ACD to address three issues: patterns of use and circulation of U.S. currency abroad, counterfeiting of U.S. currency abroad, and appropriate planning for the introduction of the new-design $100 note. The successful introduction of the NCD $100 note was viewed by the U.S. government as extremely important because it represented the first significant redesign of U.S. currency in nearly seventy years. The ACD recognized that a smooth introduction of the NCD note in 1996, particularly internationally, was important because the majority of $100s in circulation was estimated to be held abroad (table 1.1). Both ICAP and JIST activities consisted of teams study trips to areas of the world where U.S. dollars (USD) were known to circulate in significant quantities. Prior to the introduction of the NCD $100s, the teams also studied where to establish the extended custodial inventory (ECI) facilities to encourage both recirculation of fit currency and repatriation of old-series currency.5
Sources: Columns 1 and 2: Treasury Bulletin, various issues, Table USCC‑2. Figures include vault cash but exclude coin. Column 4: Federal Reserve Board Flow of Funds Accounts (Z.1. Statistical Release, Table L.204, line 22). In addition, the ICAP and JIST teams gathered information that assisted in the development of educational materials to inform USD users abroad about the characteristics of the new notes. The educational program for the NCD $100 was designed to avoid the kind of confusion and panic that occurred in Russia when the Series 1990 $100 note was introduced. During that period, the U.S. Ambassador to Russia had to appear on local television to address incorrect rumors that older-series notes were to be recalled. The public education program described the new design's security features as well as the U.S. government's no-recall policy. 1.2 Design of the StudyThe study takes account of available information and understanding accumulated by the U.S. Treasury, the Federal Reserve System, and the U.S. Secret Service about U.S. currency holdings and counterfeit activity abroad. In accordance with the congressional mandate, the study is based on three components: models of U.S. currency usage abroad, models of counterfeiting abroad, and information obtained from country surveys of cash handlers and others knowledgeable about the extent of currency usage and counterfeiting issues abroad.6 The U.S. Treasury, the Federal Reserve, and the U.S. Secret Service obtained information on currency usage and counterfeiting from a variety of sources, including U.S. Customs reports, shipment data from international banknote wholesalers and published proxies for those shipments, estimates based on in-country surveys from USD-using countries, national surveys of domestic currency holdings, and a variety of empirical models developed by the Federal Reserve that estimate international flows or holdings based on assumptions concerning international currency usage. On the counterfeiting side, the U.S. Secret Service collects information from around the world on counterfeits that have been passed or seized and related information from country surveys. In addition, the Federal Reserve collects data on counterfeits found in deposits at Federal Reserve Banks. Finally, using data collected when Federal Reserve Bank cash offices process bank deposits and data on counterfeit notes passed both domestically and internationally, the Federal Reserve has developed models to estimate the quantity of counterfeit U.S. currency in circulation. 1.3 International Demand for the U.S. DollarBecause of its relative stability and near-universal recognition and acceptance, USD function as both a store of value and a medium of exchange when other stable or convenient assets (for example, national currencies) are not available. Thus, during times of economic or political crisis, a stable and familiar currency, such as USD, often is sought as a portable and liquid hedge against possible devaluation. Similarly, USD are a popular medium of exchange in regional or cross-border trade when credit markets are undeveloped or banks are underdeveloped or unreliable. U.S. currency in the form of banknotes (paper currency) in circulation outside the U.S. Treasury and the Federal Reserve System was about $759 billion by the end of 2005.7 Current estimates indicate that the proportion of U.S. currency held abroad is as much as 60 percent of the amount in circulation, or roughly $450 billion. Table 1.1 shows the total amount of U.S. banknotes in circulation as well as the share attributed to the $100 denomination. In value terms, the share of USD held as $100s has increased from around 21 percent at the end of 1965 to nearly 72 percent at the end of 2005. In addition, the share of $100 notes estimated to be held outside the United States has also increased. As shown in the right-hand column of the table, the share of $100 notes held outside the United States rose sharply over the period from 1975 to 1995 and then remained relatively stable at around two-thirds of all $100 notes since 1999. The international circulation of U.S. currency in Europe expanded after World War I in the wake of the hyperinflation induced by the obligations arising from the Treaty of Versailles.8 At that time, U.S. currency was viewed favorably because the United States was still on the gold standard, while Great Britain, whose currency was the leading alternative to U.S. currency, remained off the gold standard until May 1925. Other countries, such as Panama, adopted U.S. currency as their official currency. In the past two decades, the international usage of U.S. banknotes expanded largely because of two events: the breakup of the Soviet Union and episodes of high and volatile inflation in Latin America. During a period of instability, the magnitude of the inflows of U.S. banknotes depends on a country's experience with U.S. currency in the past and its economic circumstances. In particular, demand for USD appears to depend on two factors. The first factor is the ability of people to purchase U.S. banknotes, and the second factor is their confidence in the domestic banking system. The less confidence people have that the value of their bank holdings will be protected, the more likely they are to want to hold U.S. banknotes. Similarly, the more developed the banking system, the more likely it is that people will have a wide variety of options for saving and for making transactions. Because many holders of U.S. currency view it as a form of insurance against future instability, they are reluctant to alter their usage patterns for USD during periods of economic stability by either shifting out of U.S. banknotes or by switching to another currency, such as the euro. Since the introduction of euro banknotes in the beginning of 2002, it appeared that demand for USD waned somewhat in countries in and near the euro zone. However, responses to ICAP team inquiries indicated that USD holders have moved to holding euros in addition to, rather than instead of, USD. It is likely that underlying patterns of U.S. currency usage will change slowly in countries that already use USD. In countries that do not now use USD to a significant degree, it is difficult to predict if and when a crisis prompting demand for a second currency might develop. 1.4 Measuring the Extent of International Counterfeiting of U.S. CurrencyU.S. currency's strong international presence and popularity make it an inviting target for counterfeiters: where genuine banknotes circulate and are accepted, counterfeits also have a chance of being accepted. Inside the United States, the U.S. Secret Service has jurisdiction over counterfeiting cases, and it routinely receives information about counterfeit activity from the Federal Reserve, commercial banks, and local law enforcement authorities. Outside of the United States, the U.S. Secret Service relies on its international law enforcement counterparts, contacts in the banking community, and U.S. diplomatic staff.9 Furthermore, legislation and banking regulations abroad vary widely regarding how to handle U.S. counterfeit notes when they are found. Thus, without ongoing, direct contact with its foreign law enforcement counterparts, the U.S. Secret Service cannot assess the true nature of the counterfeiting threat of U.S. currency it faces abroad. Preliminary results from our investigations indicate that U.S. Secret Service agents are notified more promptly today about suspected counterfeiting through the information channels and reporting mechanisms (for example, the US DOLLARS website) that have been developed. 1.5 Organization of the Remainder of the ReportThe remainder of the report is organized as follows. Chapter 2 reviews the U.S. currency public education program. Chapter 3 discusses the ICAP country visits and highlights the information on international U.S. currency usage obtained from these visits. Chapter 4 presents the estimates of the quantity and location of U.S. currency abroad. Chapter 5 discusses the international distribution of U.S. currency. Chapter 6 reviews global counterfeiting of U.S. currency and what is known about the geographic distribution of counterfeiting activity abroad. Chapter 7 presents a model and estimates of the overall potential size of international counterfeiting activity of U.S. currency. Chapter 8 provides a brief summary and conclusion. 2 The U.S. Currency Public Education ProgramThe three elements of the ACD's counterfeit deterrence program are an effective currency design, law enforcement, and the public education program. The ICAP teams had many opportunities to assess the effectiveness of the U.S. currency public education program during their visits abroad. The information gathered by ICAP teams since the introduction of the NCD $100 note in March 1996 helped define the content for the public education program.10 In particular, observations of ICAP teams indicated that educating the public both domestically and internationally is an important component of any design change. As a result, revisions to the U.S. currency public education program followed the release of the Series 1990 $100 design and the Series 1996 NCD. In October 2003, the public education program for the Series 2004 New Color of Money (NCM) $20 note included a comprehensive program for both the domestic and international users of U.S. currency. 2.1 Overview: Introduction of New Currency DesignsThe ACD's goals for the launches of the Series 1996 NCD and Series 2004 NCM were quite similar and included four broad areas. First, the currency design added easy-to-use public features to assure USD users of the authenticity of their currency. Second, because the NCD design was the first major change in U.S. currency design in nearly seventy years, raising public awareness of the new features was essential if the features were to be effective and useful. Third, in order to avoid disruption to markets and unnecessary worries to USD users, the information programs for both series (NCD and NCM) reminded the public of the U.S. government's no-recall policy. Finally, the addition of the new security features would increase the difficulty of passing counterfeit U.S. currency. In order to meet these goals, the ACD took two concrete steps. First, the U.S. government conducted an international education program, which facilitated the smooth introduction of the new design. Second, the Federal Reserve established a network of facilities to hold and redistribute USD to the international market (discussed in chapter 5). The ECI facilities have increased the ready availability of U.S. banknotes abroad, thus facilitating the penetration of new-design notes in the international marketplace. Moreover, their presence has enabled the Federal Reserve to remove many of the older-design notes from international circulation. The remainder of this chapter reviews the U.S. government's program to introduce the NCD notes and the lessons drawn from that experience for the introduction of the NCM notes. Additional details on the ECI program and its results are in chapter 5. Additional details about counterfeiting and the U.S. Secret Service's programs to reduce it are in chapter 6. 2.2 Introducing the New Currency Design (Series 1996 NCD)In the mid-1980s, the ACD became concerned that U.S. currency would become increasingly vulnerable to counterfeiting because of rapid advances in reprographic technology. As a result, the ACD recommended a redesign of U.S. currency to the Secretary of the Treasury to improve the security and integrity of U.S. currency. The new currency design included several new counterfeit-deterrent features to prevent the use of equipment, such as desktop computers, scanners, and printers to produce counterfeits. Moreover, the ACD recognized that the ongoing improvements in reprographic technology would make the counterfeiter's job increasingly easy. To combat that threat, U.S. currency would have to undergo a redesign every seven to ten years. Because new counterfeit-deterrent features would be effective only if consumers and cash handlers recognized and actively used them, the ACD approved an expanded education program to increase the public's awareness of the new security features. The educational effort drew on the combined resources of both public and private organizations to communicate key messages regarding the new design to USD users worldwide. The March 1996 introduction of the NCD $100 notes was free of major problems, and, in general, the currency itself and the informational materials were well received. The NCD $100 notes circulated without any significant disruptions both within the United States and abroad. Before the introduction of the NCD $100, the ACD had concerns about countries like Russia, where U.S. currency plays an important role in the population's savings and in the country's banking system. Because the Russian public might be suspicious about the change and the potential rejection of the old-design notes, coupled with uneasiness about how the NCD might cause disruptions in the marketplace, the successful introduction of the NCD $100 note was especially welcome. Hence, a smooth international introduction was a critical concern throughout the planning process and received significant attention as part of the overall strategic plan. Despite the general success of the NCD $100 introduction, the follow-up education programs for the $50, $20, $10, and $5 notes were somewhat less successful in the international markets because, at that time, we believed that these denominations primarily circulated within the United States. Throughout the ICAP visits since March 1996, international banking and law enforcement representatives suggested three types of changes for future introductions of new designs. First, banks indicated that the elapsed time between the unveiling of the new design of a note and its issue date was insufficient. Some banks and currency exchange houses, particularly in Latin America and the Caribbean, did not receive the relevant information until after the introduction of the lower-denomination NCD notes. Second, banks and other USD users had great difficulty obtaining additional educational materials about the new U.S. currency in appropriate languages after the immediate introduction period, and in some cases, supplies of the materials in certain languages were insufficient. Diplomatic contacts did not always know where to obtain more materials, and the materials themselves did not indicate where to obtain additional copies. The third suggested change heard during ICAP visits involved requests for specific training on handling and authenticating NCD notes. Both cash handlers and law enforcement officials in the countries visited expressed interest in training on the security features beyond that available in the public education materials. 2.3 International Education and Training (Series 2004 NCM)To address these concerns, the public education program for the introduction of the NCM notes included specific programs for international USD users, some made possible through the rapid development of the Internet in the late 1990s. Because nearly every bank and institution has Internet access, the public education program evolved to provide materials and ordering forms via the Internet (www.moneyfactory.gov/newmoney). In addition, adequate stocks of informational materials in multiple languages were readily available to meet ongoing needs, and the U.S. Secret Service arranged with the appropriate field offices to provide training to cash handlers and law enforcement officials who expressed interest in more-extensive training on the security features. In addition to training efforts by the U.S. Secret Service, the public education and awareness program sponsored a number of international seminars, roundtables, and training sessions. Since the introduction of the NCM $20 note, more than seventy-five education sessions were conducted in Argentina, Bolivia, Canada, the Dominican Republic, Ecuador, El Salvador, Greece, Mexico, Panama, Peru, the Philippines, and several cities in Russia. To support the introduction of all denominations, educational brochures and posters were produced in as many as two dozen languages, with additional training aids (such as videos, PowerPoint presentations, and CD‑ROMs) created in English and a limited number of other languages. To date, more than 5,800 orders for more than 9.4 million pieces of educational material have been placed and shipped to international addresses in more than 100 countries. In addition to the materials developed for use by the public, a reference resource for U.S. embassy and consulate personnel was developed to provide public information and economics officers with details about the redesigned currency. In addition, the U.S. Treasury sends cables regularly to U.S. Embassy contacts to provide updates regarding the currency redesign program. During several ICAP visits, team members received excellent reports regarding the efforts by local U.S. Embassy staff to prepare businesses, financial institutions, and the public for the pending change to U.S. currency. Likewise, the international news media proved to be an effective resource in communicating important information to businesses and citizens abroad regarding changes to U.S. currency. Press materials were developed for various NCM milestone events, such as identifying the next denomination for redesign, unveiling of new designs, and announcing issue dates for new-design U.S. banknotes. Materials developed were translated into two dozen languages and were distributed to media outlets worldwide. While the total impact of media outreach cannot be fully measured, targeted media monitoring identified significant news coverage about the redesigned currency in large and small media markets around the world. 3 Country Surveys of Currency Usage: The ICAP Trips3.1 Overview of the Currency SurveysThe NCD $100 note issued in 1996 represented a dramatic design change for U.S. currency. Some difficulties had followed the foreign introduction of its predecessor, the Series 1990 $100 note.11 Hence, the ACD sought a smoother introduction for the Series 1996 notes. During 1994 and 1995, Joint International Study Teams (JIST) conducted a series of trips abroad with the goal of addressing three sets of questions: First, where and how does U.S. currency circulate outside the United States? Second, where and how do U.S. counterfeits circulate, and how are they detected and handled outside the United States? Third, what should be done to make the introduction of the NCD $100 notes as smooth and trouble free as possible? The teams usually consisted of officials from the U.S. Treasury, the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York, and the U.S. Secret Service. The teams met with officials from U.S. embassies, consulates, and related institutions; officials of the host-country finance ministries and central banks; counterfeiting enforcement officials; currency dealers and handlers at banks, currency exchanges, and valuables-handling services; and various trade associations representing these groups. In addition, other authorities, organizations, businesses, and individuals were visited, depending on the level of USD usage. In 1994, the JIST members first visited wholesale banknote distribution centers in Europe and Asia to assess the reception that a newly designed $100 note might meet by the banks and other institutions involved in distributing U.S. currency internationally. Next, the JIST representatives visited the two countries that were believed to have the largest holdings of U.S. currency, Argentina and Russia, as well as Belarus, a neighbor of Russia. Then, in September and October of 1995, JIST representatives visited the Middle East, a region that historically had been a significant importer of USD. The countries visited on this trip were Turkey, Egypt, Bahrain, Saudi Arabia, and United Arab Emirates. After the 1996 legislation, ICAP teams made three trips to Asia to study U.S. currency usage in eight countries: Cambodia, Hong Kong, Indonesia, Korea, the Philippines, Taiwan, Thailand, and Vietnam. In 1997, ICAP teams also conducted a trip to four countries in Eastern Europe that were using USD as they transitioned from centralized, Soviet-style economies to market economies: Bulgaria, Latvia, Lithuania, and Poland. In 1997 and 1998, two trips were made to six Latin American countries that have had varying degrees of USD usage: Brazil, Colombia, the Dominican Republic, Mexico, Panama, and Paraguay. In 1998, a trip was taken to South Africa, which had become an important source of U.S. currency counterfeits. In 1999, ICAP teams visited three other Latin American countries with varying degrees of U.S. currency usage: Chile, Argentina, and Peru. After the issuance of the first ICAP report in 2000, ICAP teams visited China, Ecuador, El Salvador, Russia, South Africa, Switzerland, and Turkey. After the issuance of the second report in 2003, ICAP teams revisited Bulgaria, Cambodia, Hong Kong, Peru, Romania, Russia, Singapore, Thailand, and Vietnam and made visits to Austria, Bolivia, Bulgaria, Greece, Ukraine, and Kazakhstan. The ICAP visits opened communication channels between U.S. government representatives, especially U.S. Secret Service field agents posted in other countries, and international commercial bankers, global and regional banknote wholesalers, and valuables handlers. These relationships support the exchange of information and can be instrumental in dealing with issues associated with U.S. currency and counterfeiting activity in international markets. 3.2 Criteria for Country SelectionThe ICAP teams selected the locations for visits and follow-up contacts based on business, economic, and security considerations. Specifically, the teams visited places that had large U.S. banknote inflows or outflows, and places where U.S. currency activity was otherwise indicated to be significant by Federal Reserve and U.S. Secret Service contacts and reports. One exception was Colombia, which was selected because it has consistently been a major source for U.S. currency counterfeits smuggled into the United States and successfully passed on to the public. Table 3.1 lists the ICAP visits by country and date.
3.3 Patterns of International U.S. Dollar UsageU.S. currency is widely used in many countries as a store of value, a transaction medium, or a unit of account, even when it is not the official currency.12 In countries with underdeveloped banking sectors, banknotes settle transactions of all magnitudes; in countries with the additional burden of unstable currencies, USD are held as a store of value, used for many transactions, and often are the unit of account, especially for larger transactions. Even in some countries with developed banking sectors and stable currencies, USD are the preferred currency for travelers, for cross-border trade, for settlement of large cash transactions, and for transactions in the informal sector. The countries visited by ICAP teams provided examples of the varying conditions in which people choose to use and hold U.S. banknotes. Although the relative importance of particular reasons varies with economic and political conditions, the ICAP teams found five basic motivations for holding and using U.S. banknotes. First, in times and places where the political or economic situation is uncertain, USD are held for security against inflation and general calamity. Second, expatriate workers throughout the world often carry or send portions of their earnings to their home countries in USD; between visits home, some of these workers hold U.S. banknotes outside banks. Third, travelers to other parts of the world carry USD because they are easier to exchange than local currencies. Fourth, cross-border trade in many areas is conducted largely in USD. Fifth, the informal sectors in many economies are highly dollarized. Although the circumstances in each country are unique and it is difficult to generalize, during a crisis, demand for USD (or indeed any other currency that circulates widely outside its home country) tends to follow certain patterns.13 A crisis, often with both political and economic overtones, arises that leads to increased U.S. currency usage. In many cases, growing fiscal deficits are eventually financed by rapid money creation, which leads to inflation. Surging prices sharply reduce the purchasing power of the domestic currency and the value of accumulated savings. Monetary and fiscal reforms are proposed or promised, but if they come at all, their arrival is usually slow and erratic. Inflation is correspondingly erratic, which in turn generates uncertainty about the future purchasing power of both banknotes and bank holdings denominated in domestic currency. Similarly, high and unstable inflation complicates the calculation and evaluation of any large or long-term financial transactions or investments, such as leases or time deposits. Residents of countries experiencing these crises naturally seek other, more-stable assets, and the U.S. currency is often the most convenient and familiar of the available assets. Similarly, they seek to set prices and conduct financial negotiations in terms that are less likely to be affected by domestic inflation. Thus, as inflation accelerates, the first use of the dollar is as the unit of account for large-scale and longer-term transactions in the economy. As dollarization spreads, more transactions for large items like cars and real estate are either priced in dollars or conducted in U.S. currency. As more and more residents realize that having USD will prevent further losses, U.S. banknote inflows accelerate. In a simple model of this process, the demand for the foreign currency -- in this example, U.S. banknotes -- depends on the variability of inflation rates and on the difference between the inflation rates of United States and the developing country. The larger the variability and the difference, the greater will be the demand for USD.14 The degree to which a country becomes dollarized and the degree to which residents prefer U.S. banknotes to dollar-denominated bank accounts both depend on confidence in the domestic banking system. Periodic bouts of inflation often wipe out the savings held in domestic currency and encourage flight to other assets. Interest rate premiums and indexation of accounts for domestic inflation are alternatives to dollarization, but they are only effective when people have confidence that they will actually provide full protection against inflation. Similarly, allowing dollar-denominated deposits is not always sufficient to eliminate a flight to U.S. banknotes: The bitter experience of having one's foreign currency account confiscated, devalued, or made inaccessible even once is enough to keep many people from trusting banks for a very long time. A country's demand for U.S. banknotes also depends on its economic circumstances: to purchase USD, countries must have something of value to exchange. Thus, richer countries or countries with well-developed export sectors are more likely to be able to afford to buy USD. Although U.S. banknotes flow into countries when the domestic currency weakens or political crisis looms, they often remain after the crisis passes. For example, an estimated 50 percent of the U.S. banknotes that flowed into Argentina in the late 1980s, into the Middle East before Operation Desert Storm, and into Taiwan after the 1996 crisis in the straits is still in those areas. Thus, it is reasonable to anticipate that USD will remain abroad even after local currencies stabilize in parts of Eastern Europe, Eurasia, and Latin America. 3.3.1 Dollarized Economies: Ecuador and El Salvador15Ecuador and El Salvador both dollarized in the past several years, and in both countries dollarization proceeded smoothly. However, their paths to dollarization were radically different. In January 2000, Ecuador found itself in political and economic crisis, with high inflation, a depreciating currency, and falling income. Under these circumstances, Ecuador announced that it would begin withdrawing its national currency, the sucre, and shift to U.S. currency over a short period beginning in March 2000. Despite the fact that Ecuador's dollarization occurred rapidly, it worked to stabilize the economy. In contrast to Ecuador, El Salvador dollarized in 2001 after having its national currency exchange rate pegged to the dollar for several years. Rather than recall its national currency, as Ecuador did, El Salvador simply did not re-issue colons when they were returned to the Central Bank in the normal course of business. The U.S. currency has replaced the colon relatively quickly in the cities, but the transition has been slower in the countryside. As with Ecuador, the initial experience with dollarization has been positive. Despite recently suffering two devastating earthquakes, a collapse of coffee prices, and a recession, El Salvador was able to benefit somewhat from lower interest rates and relative economic stability. Both countries are relatively small and poor, and thus the amount of U.S. currency in circulation in each country is estimated to be relatively small, no more than $1 billion in each. 3.3.2 RussiaRussia and some other former Soviet republics have suffered from high inflation, economic instability, an underdeveloped banking sector, a history of confiscation of bank deposits and of unwarranted and inequitable currency recalls, and, until recently, a lack of convertibility between local currencies and "hard" currencies such as USD. These conditions have contributed to a high level of U.S. currency use in transactions, accounting, and savings. Based on the study teams' observations in western Russia and Belarus, it is likely that the majority of households across Russia hold some USD, and many households use USD as their chief store of value. The prevalence of USD, the sophistication of USD users, and the degree to which news and rumors about USD spread is quite high in Moscow and a few other financial centers but not elsewhere in Russia. The official attitude toward the prevalence of USD in Russia is mixed. Although USD may be legally held in cash or in bank accounts, the Russian Central Bank supports "de-dollarization," or a return to the ruble. Interestingly, in the absence of a suitable alternative medium for transactions, USD were used as a settlement medium within Russia and among countries that were formerly part of the Soviet Union after the collapse of communism but before the massive inflation of the 1990s. Though USD had a substantial foothold in Russia, its usage grew further during the rapid inflation. On average, Russians imported about $2 billion per month in U.S. currency from about 1994 to 1996.16 Later, in 1998 and 1999, U.S. banknote exports to Russia slowed somewhat, reflecting increased financing difficulties within Russia after the unexpected default on debt obligations in August 1998. The event caused some banks in the wholesale international currency trade to tighten the terms on which they made short-term credit extensions to Russian banks. In addition, Russia raised the tax on imported foreign currency. An important factor restraining currency imports into Russia could well have been the softness in the world oil market over the early part of this period, which reduced the resources available for U.S. banknote purchases from abroad. The introduction of the euro banknotes in 2002 resulted in a decline in demand for USD, as the euro immediately became the currency of choice for Russians saving for travel to European destinations. In addition, Russians have become more attuned to the fluctuation of the value of the euro against the dollar and have shown some inclination to buy euros when they perceive the euro to be on the rise. The Russian banking system continues to develop in fits and starts, and, accordingly, saving in banknotes remains popular but is likely to be displaced by saving in banks in the long run. In the short run, however, increased uncertainty about Russia's political and business conditions will continue to be marked by inflows of USD. Indeed, commercial bank shipments to Russia in 2005 reached their highest level since 1998. 3.3.3 EurasiaCountries in Eurasia appear to follow Russian patterns of U.S. currency usage. ICAP teams found substantial U.S. currency usage for saving and private transactions in Kazakhstan as well as Ukraine in 2004, and it seems likely that USD are similarly used in the remaining countries as well. Countries in this region receive U.S. currency both through commercial currency shipments and through nonbank channels, with commercial shipments dominating when demand increases because of economic or political instability or the beginning of vacation seasons. In the countries and areas closer to the euro zone, the euro has become quite popular, especially for short- and medium-term saving (for example, for travel to the euro zone). As in Russia, in the longer term, USD are likely to be held for long-term savings until the banking and financial systems in these countries develop and the economic and political situation becomes more stable. 3.3.4 Argentina: A Long‑Term Dollar UserFor the past several decades, Argentina has experienced high and chronic inflation. In spite of eight major stabilization plans (an average of two per decade) and countless other attempts at reform, Argentina never managed to reduce its annual inflation to a double-digit rate for more than a year at a time until the 1990s. The surges of hyperinflation in 1975 and in the late 1980s resulted in a persistent dollarization of the economy. Beginning in the 1970s, USD were increasingly used for settling current transactions and as a unit of account. In April 1991, Argentina embarked on its most successful and ambitious stabilization attempt, pegging its local currency to the dollar at parity using a currency board structure, in which the supply of domestic currency was rigidly limited by the amount of foreign reserves held by the central bank.17 The new policy reversed Argentina's high inflation, which had averaged over 320 percent per year for the 16 years before the creation of their currency board. After the currency board came into existence, inflation was virtually nonexistent for over a decade. However, after a series of shocks and considerable difficulty in maintaining fiscal discipline, the dollar peg finally collapsed in late 2001, and Argentines saw their national currency rapidly depreciate from a 1‑to‑1 peg to about a 4‑to‑1 peg. Since the 2001 crisis, conditions in Argentina have stabilized somewhat and U.S. currency inflows have slowed. Clearly, while Argentina's currency board brought some economic tranquility, especially in terms of reduced inflation and interest rates, in the end, the recurring fiscal problems overwhelmed the economy and policymakers opted to devalue the national currency. The large group of U.S. banknote holders in the country has benefited greatly from their decision to hold cash. Well over $20 billion in U.S. banknotes may have been in Argentina in the early 1990s, and perhaps $50 billion or more may be there now. 3.3.5 Southeast AsiaBanks in Hong Kong and Singapore trade USD with clients for travel and for cash transactions, and they supply a large network of correspondent banks in countries where U.S. banknotes are used heavily, including Cambodia, China, India, Indonesia, Korea, the Philippines, Taiwan, Thailand, Vietnam, and several East African countries. The countries of Southeast Asia are at quite different degrees of development, and their U.S. currency usage patterns vary accordingly. In the more-developed economies, such as Hong Kong and Singapore, USD are held for travel and are used for cash payments in the ports.18 Heightened political tensions between Taiwan and China have led Taiwan residents to import substantial amounts of USD for use as precautionary savings, though anecdotal reports suggest that they might recently have begun to diversify into euros. In Thailand, USD are used heavily by visitors but less so by residents. In less-developed countries, such as Vietnam, USD are widely used for saving and large transactions despite regulations requiring all commercial transactions to be priced and conducted in the local currency, the Vietnamese dong. In Cambodia, the least-developed country in the region visited by ICAP teams, USD are used nearly universally, although the existing local currency is used for small transactions. In Cambodia, as in Vietnam and Thailand, USD largely flow into the country in the hands of tourists, travelers, and residents returning from abroad and leave the country through commercial banking channels. The condition of lower-denomination USD throughout the region, especially in Cambodia, is quite poor because the cost to return worn banknotes back to the United States through the international banknote dealers and replace them with new banknotes is prohibitive. While there is a low incidence of counterfeiting in the region, it is worth noting that circulating poor-quality banknotes can compromise the ability of USD users to settle transactions because of the difficulty associated with authenticating U.S. currency because of due to soil and wear of the security features. U.S. currency usage in these countries is likely to continue in its present patterns for some time to come. 3.3.6 Other AreasMuch of Eastern Europe was highly dollarized in the early years after the collapse of the Soviet Union, but the use of USD has waned to the extent that these countries have become more stable and have begun to develop a financial infrastructure. Nonetheless, USD and other banknotes are still heavily used for tourism, for cross-border trade, and in the informal sector, with the euro increasingly used in and near the euro zone. This transition is ongoing; during the mid-to-late 1990s, USD were estimated to represent about half of the currency stocks in the two Baltic countries visited by ICAP teams, Latvia and Lithuania. At present, however, U.S. currency usage in the Baltic countries appears to have dwindled in the face of rapid economic and financial development. In contrast to the Baltic countries, U.S. currency usage has persisted in other transition economies. When the currency of Bulgaria, the lev, collapsed in 1996, falling to less than one-seventh of its purchasing power in USD at the beginning of the year, the country imported as much as $50 per person. The arrival of the euro appears to have replaced the German mark as well as some of the U.S. banknotes as it became more convenient to use the currency of neighboring countries. In Western Europe, the banking sector is highly developed, and the domestic currencies are generally stable. Thus, USD are rarely used there as a store of value or means of transaction. However, several large wholesalers who do not receive U.S. banknotes from the Federal Reserve are based in Western Europe; they supply USD to, and buy USD from, correspondents in Eastern Europe, the Middle East, and Africa and sell USD to customers of their own branches for use in tourism and business in other parts of the world. All forms of U.S. currency usage are represented in the Middle East. Throughout the region, USD are the preferred currency for travelers. In the Gulf States, local currencies are stable, so USD are reserved for cross-border trade and travel. Traders from the rest of the Middle East and Eurasia use USD for their purchases. Residents carry USD when traveling outside the region, and expatriate workers are often paid in USD and remit USD to their home countries. In Turkey, USD are used for both trade and travel and for domestic transactions and saving because of persistent high inflation. In Egypt, USD are used very little except for travel. U.S. currency usage has had a long history in Latin America and the Caribbean. Many Latin American countries used USD exclusively or in large part at one time in their history: Argentina, the Dominican Republic, Mexico, Panama, Peru, and Uruguay fall under this heading. Residents of these countries began to use USD for the same reasons as in other countries, and U.S. currency is by far the most familiar of all foreign currencies in Latin America. It should be noted, however, that two countries in Latin America, Chile and Brazil, appear to have minimal U.S. currency usage despite histories of high inflation. As far as ICAP teams could determine, the low U.S. currency usage is due to successful indexation schemes that gave individuals confidence that the value of their savings would be preserved. 3.3.7 Inferences Regarding Countries Not Visited by ICAP TeamsAlthough the ICAP teams were not able to visit every country in each region, educated guesses were made about U.S. currency usage for several of the unvisited countries by drawing on a variety of economic intelligence and information from various businesses and U.S. Secret Service contacts. For example, information obtained by visits to South Africa indicates that U.S. banknotes are the dominant currency used for cross-border trade and tourism throughout Africa. Similarly, U.S. currency usage is likely widespread in countries in Latin America, Eastern Europe, and Eurasia not yet visited by ICAP teams. 3.4 Judging the Plausibility of Estimates of International Dollar Holdings from Country SurveysThe Federal Reserve estimates that as much as 60 percent of USD, or perhaps $450 billion, is held outside the United States.19 As shown in table 1.1 above, the quantity of USD in circulation has been increasing steadily since 1980, and a sizable share of this growth can be attributed to international demand. U.S. currency is thus a valuable export whose quality and integrity should be protected. As with many products, users have alternatives; in this case, alternatives include the British pound, euro, Swiss franc, Japanese yen, Hong Kong dollar, and Singapore dollar. How plausible are the estimates that $450 billion in U.S. banknotes are held abroad? The methodology underlying the aggregate estimate is the subject of chapter 4. The precise amounts that are held abroad have been the subject of a great deal of speculation for some time: As early as 1921, as the inflationary implications of the Treaty of Versailles were starting to leave an imprint, the Federal Reserve Bank of New York began publishing estimates of currency flows to Europe. Table 3.3 presents some preliminary results from the various U.S. Treasury and Federal Reserve surveys. As expected, the per capita estimates tend to be higher in countries that have experienced high rates of inflation, even when the peak inflation experience occurred much earlier. The estimates suggest that the 2.6 billion residents in the thirty-two countries visited held around $95 on average. Because these countries represent about 40 percent of the world's population and appear to hold around $250 billion in currency, the countries not yet visited might well hold enough USD to account for foreign holdings in the neighborhood of $450 billion.20 In particular, table 3.3 does not include estimates for several countries in Latin America, Eastern Europe, and Eurasia with high U.S. currency usage.
Notes: The source data for the average annual inflation rate is based on monthly Financial Statistics (IFS) data, and, when possible, ten-year averages of such data. The remaining data in the table were drawn from the CIA World Factbook website. For the currency holdings, estimates were provided during the teams' visits to each country and thus are estimates as of the most recent trip to each country. ICAP teams in the Middle East also found that about $15 billion was in the Persian Gulf in Saudi Arabia, Bahrain, the United Arab Emirates, Kuwait, Iran, and Iraq. A similar amount was thought to be in India and Pakistan. * Based on purchasing power parity GDP. Return to table … Not applicable Return to table Thus, the country trips tend to confirm the relatively large estimates of currency held abroad. One substantial area of uncertainty, however, remains. Domestic survey evidence on individual holdings of currency in the United States shows only about 10 percent of the total U.S. currency stock as being located inside the United States.21 If 60 percent or so were held abroad, 30 percent of the currency stock would remain unaccounted for. The true domestic figure is very likely larger than 10 percent, but the possibility that foreign holdings are substantially larger than 60 percent cannot be ruled out. 3.5 Changing Conditions in Countries SurveyedConditions in some countries have changed significantly over the course of the program. Argentina experienced a severe crisis from which it has yet to recover fully and that spread into neighboring Uruguay. Ecuador and El Salvador dollarized. The precise patterns of U.S. currency usage may have changed because of these events, but many of the general patterns almost surely remain, so the information from the trips is likely to remain generally valid. In addition, the ongoing relationships and visits from residents of these countries provide periodic updates. 3.5.1 Transaction TechnologiesAs countries develop and stabilize, noncash transactions and savings mechanisms such as checks, credit cards, debit cards, and bank accounts can displace banknotes. However, discussions during the ICAP teams' trips indicate that people who have been driven to U.S. currency usage by crisis are often extremely cautious about moving away from the familiar U.S. currency. At the wholesale level, payment systems that displace USD are embraced when credit systems and contract enforceability are established; these developments occur more readily within countries than across borders. Since the beginning of the program, several bold experiments in electronic cash were launched, and small-scale systems are beginning to develop, most often in smaller, advanced economies with concentrated banking sectors. 3.5.2 The EuroThe introduction of the euro banknotes in January 2002 generated a small short-run increase in demand for U.S. banknotes as a "bridge" currency, but over the longer run, the euro has apparently been displacing the U.S. currency in some instances. Three groups of people who used USD prior to 2002 might switch to euros at some point. First, residents of the euro area who formerly carried USD for travel outside their home countries began to find that, in many places, they could exchange euros just as easily and cheaply as USD.22 These USD users apparently shifted to euros quickly, within a year or two of the euro's introduction. Second, USD users in countries close to the euro area have found that euros are just as convenient, and in some cases more convenient, than USD. This transition also appears to have occurred relatively quickly, over the course of a couple of years. Third, although residents of countries experiencing political or economic crisis might in the long run prefer to hold euros, second-currency-holding habits change only very slowly. Thus, this group of USD users is also unlikely to switch away from USD very soon, if ever. Overall, those who use U.S. currency as a store of wealth seem to be cautious about switching to euros instead of USD, though many are apparently now holding both euros and USD. However, it should be noted that the euro zone is expected to expand over the next several years, which might further increase the scope of euro banknote usage by current holders of USD, as the euro becomes their national currency. 4 Models of International Demand for and Use of U.S. CurrencyThe Federal Reserve has developed several statistical models for estimating stocks and flows of USD abroad.23 The models indicate that between 50 percent and 70 percent of U.S. currency is now held outside the United States and that the growth in U.S. currency in circulation since the late 1980s has been driven mostly by foreign demand. These models use confidential data on currency shipments to and from the Federal Reserve Bank of New York, data collected by the U.S. Customs Service through its Currency and Monetary Instrument Report, data on cash processing at Federal Reserve Banks, and less formal information collected during the study trips. 4.1 Data Sources4.1.1 Major Wholesale Banknote DealersCurrently, monthly reports on the volumes, sources, and destinations of incoming and outgoing international currency shipments are provided to the Federal Reserve Bank of New York by large commercial banks and other banknote brokers. These reports have been provided since 1988 and were provided for a period between World War I and World War II. About $130 billion in U.S. banknotes, on net, moved abroad via wholesale banknote brokers in the eighteen years from 1988 through 2005. Before 1992, the bulk of the net value went to Latin America, primarily Argentina, which received a little more than one-third of total net shipments from the United States to the rest of the world from 1988 through 1991. Since then, turbulence in Eastern Europe and Eurasia has sharply boosted shipments, especially to Russia. Indeed, the shipments have been so large that, from 1988 to 2005, the broad region of Europe, Russia, and the other countries of Eurasia more than accounted for net U.S. currency shipments abroad. This growth was most spectacular from 1994 to 1996, when annual net flows to Russia averaged about $20 billion, or well over half of total net foreign shipments of U.S. currency in that period. 4.1.2 Federal Reserve Bank Cash Office Processing DataThe most complete source of indirect information on U.S. currency flows is data on currency processing at the Federal Reserve Bank's network of about three dozen cash offices. The cash offices record by denomination and, to a limited extent, by series, all currency received, processed, destroyed, and paid out or shipped to other cash offices. These data do not differentiate between foreign and domestic flows, but by comparing cash office reports on shipments of $100 notes and $50 notes with information from other sources, we can enhance our knowledge of stocks and flows abroad. These data are particularly useful in light of other data, which indicate that a noteworthy portion of U.S. banknote activity at certain cash offices arises from foreign demand for U.S. currency. 4.1.3 Currency and Monetary Instrument ReportsThe most obvious direct source of information on U.S. currency flows across U.S. borders is the Currency and Monetary Instrument Reports (CMIRs) required by the U.S. Customs Service. In principle, these reports are a rich source of information because individuals and firms making almost any shipment of more than $10,000 in cash across a U.S. border are required to file a CMIR. Nonetheless, the previous reports, issued in February 2000 and March 2003, indicated that CMIRs are neither accurate nor thorough measures of large cash shipments outside the banking sector due to a one-sided system for collecting data, the omission of some potentially large volumes of currency flows, and the inability to cope with intermediate ECI transactions.24 4.1.4 ICAP Trips and Other Institutional InformationThe Federal Reserve estimates also draw on institutional knowledge of several types, most having to do with patterns in the issuance and usage of the $100 note, the largest denomination now issued by the Federal Reserve. Two facts about the use of $100 notes suggest that the net new demand for them is coming primarily from abroad. First, although the use of $20 notes is more common in the United States than the use of $100 notes, $100 notes now make up nearly 72 percent of the dollar value of all U.S. currency outstanding. Second, the Federal Reserve Bank of New York, the primary supplier of U.S. currency to foreign markets, makes $100 note shipments that are unusually large relative to its region's share of nationwide population and income. The Federal Reserve Bank of New York accounted for 36 percent of the gross issuance of $100 notes in 2005, a figure two to three times larger than its share of population, income, or net issuance of $20 notes.25 At the same time, survey data on holdings of the $100 banknote indicate that each U.S. resident holds, on average, less than one third of one $100 banknote per person, while for every U.S. resident, about twenty $100 banknotes notes now circulate somewhere in the world. In sum, the basic information we have from surveys and the Federal Reserve Bank cash offices about the circulation of $100 banknotes is consistent with the assumption of relatively low $100 note use domestically and high $100 note use abroad. 4.2 Methods for Measuring Flows and Stocks of U.S. Currency AbroadIn terms of the geographic split in holdings, it is unwise to rely exclusively on official data sources because they often miss significant currency flows. For example, between two countries, currency often flows in one direction in the hands of travelers and in the other direction through recorded wholesale shipments between banks. 4.2.1 The Seasonal MethodThe seasonal method, as well as various other indirect methods discussed in Porter and Judson (April and October 1996) is based on the idea that the usage of U.S. currency abroad differs from its usage in the United States in some measurable respect. The method relies on three assumptions: (1) The seasonal pattern of currency demand in the United States is the same as the seasonal pattern observed for demand in Canada, (2) Foreign demand for USD has no seasonal pattern, and (3) International demand for Canada's currency is so small that the seasonal pattern of demand for Canadian currency is a domestic phenomenon. Appendix 1.1 in the previous report provides evidence of the veracity of these assumptions and details about the model. The seasonal method produces an estimate of the share of U.S. currency held abroad that rises steadily from about 35 percent in the early 1960s to around 68 percent in the mid-1990s and remains flat at this share before trailing off a bit and reaching around 67 percent in 2005.26 4.2.2 The Biometric MethodThe second estimation method is based on an approach used by biologists to estimate the size of an animal population. Biologists, like bankers, can often only see a small part of the "population" (animals or banknotes) at any one time. The approach used by biologists is to capture a sample of the animals, mark them, release them, and capture another sample later.27 If we assume that the marks do not affect the animals' ability to survive, the share of marked animals in the unknown general population will be the same as the share of marked animals in the recaptured sample. For example, suppose that a biologist wants to estimate the number of fish in a pond. The biologist catches 100 fish and marks them. Later, the biologist returns and catches another 100 fish, of which 20 fish have the biologist's mark on them. This catch would suggest that 20 out of 100 of the total fish population, or 20 percent, are marked. Because the biologist knows that 100 of the fish are marked, the biologist may conclude that the 100 marked fish represent 20 percent of the total population, or that the fish population is 500. This approach can be adapted to measuring U.S. currency abroad by combining two kinds of information: (1) data from Federal Reserve Bank cash offices on currency shipped to and from banks in their region, and (2) knowledge that most of the $100 note shipments handled by the Federal Reserve Bank of New York are to and from foreign markets. First, data on currency flows at Federal Reserve Bank cash offices provide virtually continuous samples of currency. Although currency is not literally marked when it is processed at Federal Reserve Banks, statistics for the pre Series 1990 $100 note are maintained separately from those for the 1990 and NCD series. The Series 1990 note contains an embedded security thread; the NCD note has additional security features, including an enlarged offset portrait, a portrait watermark, and color-shifting ink. The Series 1990 and NCD notes function as the marked animals. For example, when a pre NCD note is "sampled," or returned to a Federal Reserve Bank cash office, it is "marked" by being replaced with a NCD note. We know the number of NCD notes issued by each Federal Reserve Bank cash office, and we know how many return to the cash offices in later samples. Second, we make use of the institutional facts that the $100 note shipments moving through the Federal Reserve Bank of New York are mostly to and from foreign markets and that, the Federal Reserve Bank of New York handles most international shipments between commercial banks and the Federal Reserve. Thus, if we can estimate the population of USD in the area served by each Federal Reserve Bank, the currency abroad can be estimated as the population in the Federal Reserve Bank of New York area. Using the biometric method, we find that the December 2005 share of $100 notes held abroad is about 62 percent. The comparable estimate for $50 notes is about 55 percent. For $20 notes, the NCD circulation strategy, which did not destroy all old-design notes when they returned to the Federal Reserve, makes it difficult or impossible to apply the biometric method. 4.2.3 Wholesale Demand for CurrencyThe Flow of Funds Section of the Federal Reserve Board and the Commerce Department's Bureau of Economic Analysis (BEA) jointly publish quarterly estimates of international currency holdings that proxy for wholesale shipments of U.S. currency (table 1.1, column 4).28 The published series is an estimate of wholesale currency shipments that move through the international banking system. Research by Porter and Judson (April 1996) showed that such shipments constitute the vast majority of all international currency shipments, with a relatively minor amount likely being transmitted through the hands of individuals and firms and smaller financial institutions. The Federal Reserve-BEA estimate can be viewed in several different ways. First, as a benchmark for $100 notes held abroad in the last few years, this estimate closely matches the other estimates of the percentage of $100 notes held abroad. The Federal Reserve-BEA estimate of the share of $100 notes held outside the United States was 64.6 percent of total $100 notes in circulation at the end of 2005, about midway between the estimates for this period obtained from the two methods discussed above, the seasonal method (74 percent) and the biometric method (58 percent).29 Second, apart from these institutional considerations, the Federal Reserve-BEA estimates can be considered to represent international flows because they also coincide with the outliers from a simple domestic money demand specification. Judson and Porter (2001) show that, for the Federal Reserve Cash offices that are not believed to have significant U.S. banknote flows from other countries, regional demand for U.S. currency is closely linked to income and other economic factors. However, the alignment with local demand variables does not hold for the Federal Reserve Bank of New York cash office: During 2005, the Federal Reserve Bank of New York's share of Federal Reserve Banks' gross payments to circulation was 37 percent for $100 notes but only 15 percent of $20 notes. If the population served by each cash office is used as the benchmark for the normal level of demand in that region, the two significant outliers are the New York and Los Angeles cash offices.30 That finding was the deciding reason for selecting these two offices in constructing the Federal Reserve-BEA wholesale estimate. The assumption that all $100 notes issued by these two offices are sent abroad or received from abroad requires that the quantity of small-denomination notes sent abroad from these two offices as part of wholesale shipments about matches, on net, the $100 notes used domestically in the regions served by these offices. Unfortunately, this analysis cannot readily be applied to lower denominations. For denominations lower than $100, notably the $20, which is the next most widely used note, the estimates are far less clear-cut. In part, the variation in the quality of the results for these two denominations represents differences in the way these two notes are used. The $20 is a popular denomination in some developing countries, such as Mexico and other nearby Latin American countries, most likely because its purchasing power is convenient for a wide array of transactions. Various indirect methods for estimating foreign holdings suggest that the proportion of $20 notes held abroad is more than 50 percent. Because the $20 note, however, seems to be more likely to circulate outside of recorded commercial banking channels, the data on wholesale shipments that allow confirming estimates for the $100 note are much less informative for the $20 note, for two reasons. First, for a given value, $20 notes are more numerous and hence more expensive to ship than $100 notes. Indeed, data indicate that, unlike the $100 note, few $20 notes that are paid into circulation are shipped abroad. Second, anecdotal information indicates that departing international travelers are far more likely to carry $20 notes than $100 notes simply because the $20 is the primary denomination dispensed from ATMs within the United States. In sum, while various indirect methods for estimating foreign currency holdings suggest that more than half of $20 notes are abroad, the direct evidence is scanty but perhaps suggestive of a significantly lower figure. 4.2.4 Summary of EstimatesThese estimates generated by these disparate methods have diverged a bit compared with estimates for previous years, but they all indicate that between 58 percent and 74 percent of U.S. $100 notes are held abroad; $100 notes accounted for more than 70 percent of the total value of U.S. banknotes in circulation at the end of 2005.31 The biometric, wholesale demand, and seasonal methods all indicate that substantially more than one-half, and possibly as much as three-quarters, of U.S. $100 notes are in circulation abroad. For $50 notes, the seasonal method estimate (56 percent held abroad) and the biometric method estimate (52 percent held abroad) agree more closely and are both between one-half and two-thirds. It is difficult to comment on $20 notes, as their introduction has been handled differently and in a way that was not conducive to applying the biometric model to the available processing data, but the seasonal method indicates that a substantial share of $20 notes, 58 percent, circulated outside the United States as of 2005. If the average of each available estimate is applied to the quantity of U.S. currency in circulation by denomination at the end of 2005 and if it is assumed that no U.S. currency in the $10 denomination and smaller denominations was held abroad, the overall best estimate would be that 58 percent of U.S. currency, or about $450 billion, was held abroad in 2005. 5 The International Distribution of U.S. BanknotesThe International Currency Awareness Program (ICAP) and the earlier Joint International Study Team (JIST) efforts were partly motivated by a desire to improve understanding of U.S. banknote movements beyond the United States both within and outside commercial banking channels. Currency movements within banking channels -- that is, through banks that function as major wholesale banknote dealers and local retail banks, including sales and purchases of currency to and from other banks, corporations, and the public -- can be partially measured and observed because the Federal Reserve is the ultimate source or destination for many banknote shipments. However, significant volumes of banknotes also move across borders outside banking channels, and these movements are extremely difficult to measure, even in approximate terms. 5.1 International U.S. Banknote Market StructureU.S. banknotes are traded in international markets with small bid-ask spreads. While many financial institutions trade USD for other currencies in the international foreign exchange markets, approximately twenty institutions worldwide participate actively in the wholesale buying and selling (including transport and delivery) of U.S. banknotes.  d
As shown in diagram 5.1, the global wholesale banks service approximately 200 to 300 regional banks in the international markets; the regional banks in turn supply retail banks and retail distributors located in their own and nearby countries. Ultimately, U.S. banknotes make their way to and from end users of currency overseas, such as commercial establishments and individuals. Worldwide, five locations serve as the principal international distribution and consolidation hubs for U.S. banknotes: three in Europe (Frankfurt, London, and Zurich) and two in Asia (Hong Kong and Singapore). The preeminence of all these locations arises from accessible transportation networks as well as the locations' historical focus on international commerce. U.S. banknotes are distributed through international wholesale channels either as new (uncirculated) banknotes, still in the original Bureau of Engraving and Printing (BEP) packaging, or as fit notes (recirculated banknotes) in very good condition. The overwhelming preference for the majority of international market participants is for new U.S. banknotes still in the original BEP packaging because it assures the purchaser that the notes are free of counterfeits. In addition, many dollar users in international markets prefer new banknotes because new banknotes retain their condition longer than fit notes, which show signs of initial wear due to previous circulation. 5.2 The Federal Reserve's Currency Distribution MissionThe responsibility of Federal Reserve Banks for international currency distribution derives from the Federal Reserve's charge under the Federal Reserve Act (FRA) to provide an elastic supply of currency.32 The FRA does not distinguish between the domestic and international supply of currency. In practice, however, the provision of an elastic currency results in the Reserve Banks satisfying overall demand for U.S. currency both domestically and internationally. Historic |
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