Action Requested
Staff requests that the Board approve the proposed 2003 new currency budget of $510.3 million.

Discussion
Under the Board’s delegated authority, the director of the Division of Reserve Bank Operations and Payment Systems submits an annual print order for new currency to the Bureau of Engraving and Printing (BEP). The BEP reviews the print order and establishes billing rates for new currency that staff uses to prepare the annual new currency budget. The Board then prepares the budget and subsequently assesses the Federal Reserve Banks through an accounting procedure similar to that used in assessing the Banks for the Board’s operating expenses.
In August, the director forwarded to the BEP a print order of 8.2 billion notes for fiscal year 2003, which began October 1, 2002, and ends September 30, 2003. Because the BEP operates on a fiscal year, staff estimates the Board’s calendar-year budget for new currency by eliminating the cost of notes that the BEP will produce in the first quarter of the fiscal year and estimating the cost of notes that the BEP will produce in the fourth quarter of the calendar year.
Table 1 compares the Board’s calendar-year 2003 budget with the 2002 budget and 2002 estimated expenditures.

Print order (number of notes)

7,266,400

7,401,600

8,217,600

1.9%

11.0%

2002 New Currency Expenses
Staff estimates that 2002 new currency expenses will exceed the budget by $17.0 million, or 4.1 percent. The over expenditure is due primarily to higher-than-anticipated note production and currency transportation costs. Note production in 2002 will exceed budgeted production by 135.2 million notes, or 1.9 percent, which will result in printing costs that exceed the budget by $14.7 million, or 3.7 percent.

Staff and BEP management work collaboratively during the year to monitor inventories and production needs and make any necessary modifications to the print order to meet Reserve Bank demand. In preparation for the production of Series-2003 notes in January 2003, the BEP accelerated the production of Series-1996 $20 notes by printing them in the fourth quarter of the 2002 calendar year (the first quarter of FY 2003). While it is prudent for the BEP to mitigate risk by producing the Series-1996 $20 notes before beginning production of the Series-2003 design, the acceleration resulted in more $20 notes being printed during the 2002 calendar year than staff had budgeted. In addition, the BEP produced $50 notes during the fourth quarter of the 2002 calendar year to address declining Federal Reserve inventories. At the time of the last budget, staff had anticipated that this production of $50 notes would occur in calendar year 2003.²

In addition, staff has prepared lower volume print orders for the past two years because many Reserve Bank offices continued to store large inventories of currency from the Y2K build up. Instead of producing more new notes, staff expected that Reserve Bank offices would deplete existing stocks. Because some offices reduced inventories faster than others, reflecting local demand, the number of Fed-to-Fed shipments of currency increased significantly in 2002, which contributed to the 40.3 percent overall increase in estimated expenses over the budget for currency transportation costs.

2003 New Currency Budget
The proposed 2003 new currency budget is $510.3 million, or 18.5 percent greater than 2002 estimated expenses. This increase is due primarily to the significant increase in the billing rate for the new $20 note design (Series-2003) and the increase in transportation costs of new currency from the BEP to Reserve Bank offices.

Printing Federal Reserve Notes. The 2003 budget reflects a print order of 8.2 billion notes for calendar year 2003. The BEP’s billing rate for the $1 notes remains unchanged from 2002 and the billing rates for the Series-1996 design of $5, $10, $20, $50 and $100 notes increased modestly by approximately 1 percent. The billing rate for the Series-2003 $20 note, however, increased 45 percent from $0.68 per note to $0.99 per note. This increase reflects both permanent costs associated with the new design (for example, equipment and labor to run the new offset presses) and temporary expenses relating to public education and start up costs (for example, increased spoilage and decreased productivity) for the Series-2003 $20 notes.³ Because the Federal Reserve will draw down existing inventories of Series-1996 $20 notes, and initially co-circulate the Series-1996 and the Series-2003 $20, the FY 2003 order includes fewer notes (less than one billion, or about one-third of the total $20 note order) than it would if the existing stock of $20 notes was replaced with the new-design notes. As a result, the public education and startup costs are distributed over fewer notes and the billing rate per note is commensurately higher. The BEP expects the billing rates to decline for Series-2003 notes after the public education campaign is completed and there is sufficient production experience so that spoilage and productivity rates return to historical levels.⁴

Table 2 shows the billing rates by currency type based on the sophistication of security features. The 2003 billing rates reflect four types of currency produced: the $1 note, which has not changed; the $5 note, which reflects the Series 1996 design but does not include color-shifting ink; the $10, $20, $50, and $100 notes, which reflect the Series 1996 designs and include the color-shifting ink; and the Series-2003 $20 note, which includes enhanced security features.

Table 3 illustrates the number of notes by denomination that the BEP will print in 2003 compared with the number of notes printed in 2002. The $490.9 million printing cost budgeted for the 8.2 billion new notes to be printed accounts for 96.2 percent of the total 2003 new currency budget.⁵

Currency Transportation. The 2003 currency transportation budget is $13.7 million, which includes the cost of shipping new currency from the BEP to Reserve Banks, shipping currency among Reserve Banks (intra-System shipments), and returning currency pallets to the BEP. The 2003 budget for new currency shipments is $8.4 million, which is 11.1 percent higher than 2002 estimated expenses because of the increase in air shipment costs. These increases are due primarily to air freight costs resulting from a reduction in freight space on commercial airlines, an increase in the fuel surcharge, and increases directly related to the September 11 terrorist attacks (security handling surcharge and insurance premiums). The 2003 budget for intra-System shipments is $5.3 million, which is the same as the 2002 estimated expenses. These shipments move currency from offices with excess fit currency to offices that would otherwise require new currency from the BEP. Finally, the 2003 budget for returning currency pallets from Reserve Banks to the BEP is $20,000, or 9.0 percent less than 2002 estimated expenses.

Counterfeit-Deterrence Research. The 2003 budget includes $2.9 million for the counterfeit-deterrence program. The Central Bank Counterfeit Deterrence Group operates under the auspices of the G-10 central bank governors to combat digital counterfeiting.

Treasury’s Office of Currency Standards (OCS). The 2003 budget for reimbursement to the Treasury for OCS expenses is $2.8 million, which is 20.4 percent less than the 2002 estimated expenses. The OCS develops standards for Reserve Banks relating to the cancellation and destruction of unfit currency, as well as note accountability, and reviews Reserve Bank cash operations against these standards. As a public service, the OCS also processes claims for the redemption of damaged or mutilated currency and reimbursement for these expenses is included in the 2003 budget.