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Testimony of Louise L. Roseman
Director, Division of Reserve Bank Operations and Payment Systems
Distribution of coin and currency
Before the Subcommittee on Domestic and International Monetary Policy of the Committee on Banking and Financial Services, U.S. House of Representatives
March 28, 2000

Thank you for the opportunity to comment on a variety of issues that affect our nation's coins and currency. The new dollar coin and the Fifty States Commemorative Quarter program have renewed the public's interest in coins. These changes in our coinage are occurring as the Treasury Department prepares to release new $5 and $10 notes later this spring, completing the design series that began with the $100 note in 1996. Before I address the issues raised by the Subcommittee, it may be useful first to describe briefly how the Federal Reserve, as the nation's central bank, issues, distributes, processes, and accounts for currency and coin.

Role of the Federal Reserve
The Federal Reserve provides cash services to over 9,600 of the 22,000 banks, savings and loans, and credit unions in the United States to carry out its responsibility under the Federal Reserve Act "to furnish an elastic currency." The remaining institutions choose to obtain their cash through correspondent banks rather than directly from the Federal Reserve.

Federal Reserve notes account for about 95 percent of the $564 billion of currency and coin in circulation. Each year the Federal Reserve Board determines the need for new currency and submits an order to the Treasury's Bureau of Engraving and Printing (BEP). Typically, more than 80 percent of the new currency replaces currency destroyed by the Reserve Banks because it is unfit for further circulation. The remainder is printed to meet expected increases in the demand for currency. The Federal Reserve pays the BEP the cost of printing new currency and arranges and pays the cost of transporting the currency from the BEP facilities to the Federal Reserve cash offices.

The Federal Reserve distributes new and fit currency into circulation, detects counterfeits, and destroys unfit currency. When a depository institution orders currency from a Federal Reserve Bank, the Bank provides the requested shipment to an armored carrier arranged by the depository institution and charges the depository institution's account (or the account of the bank that acts as its settlement agent) for the amount of the order. Similarly, when a depository institution returns excess currency to the Federal Reserve, it receives a corresponding credit to its account. The deposited currency is stored in secure vaults until it is verified on a note-by-note basis by processing on very sophisticated equipment. During this verification, deposited currency is counted for accuracy, counterfeit notes are identified, and unfit notes are destroyed. The fit currency is returned to the secure vault and is used to fill future currency orders.

Federal Reserve notes in circulation are recorded as a liability on the Federal Reserve's balance sheet. The Federal Reserve, as required by law, pledges collateral (principally U.S. Treasury securities) equal to the face value of currency in circulation. Each day, as orders are filled and deposits are received, the Federal Reserve determines the net change and takes any necessary action to ensure the currency is fully collateralized.

The Federal Reserve's role in coin operations is more limited than its role in currency. The Mint determines the annual coin production and monitors Federal Reserve coin inventories weekly in order to identify trends in coin demand. To help the Mint plan, the Reserve Banks in March provide the Mint with their projected monthly coin orders for the next fiscal year. In addition, the Reserve Banks provide preliminary estimates of their coin needs for the two following fiscal years. The Federal Reserve buys coin from the Mint at face value, and the Mint pays the expense of transporting the coin from its production facilities to the Reserve Banks.

The Federal Reserve's coin operations consist primarily of storage and distribution but not processing because coins do not require fitness sorting. In addition to the Federal Reserve offices, Reserve Banks use more than 100 additional sites, known as coin terminals, to handle nearly 80 percent of the Federal Reserve's coin volume. Coin terminals, which are generally operated by armored carriers, reduce the transportation required and make the coin distribution system more efficient. Many retailers and depository institutions need to have coin wrapped, a service provided by armored carriers. Depository institutions order and deposit coin, like currency, to meet customer demand, and the Reserve Banks adjust the appropriate bank's account accordingly. Rather than piece-verify coin deposits, the Reserve Banks and the coin terminals generally weigh coin bags to verify the value of coin received. The Reserve Banks account for the coin in their vaults and at the coin terminals as an asset on their balance sheets.

Coin Demand
During 1999, the Federal Reserve experienced exceptional demand for all denominations of coins. In several regions, the demand for pennies, and later in the year, for other denominations, at times exceeded the Federal Reserve's ability to meet orders. The average number of coins flowing out of Reserve Banks during 1999 (minus coins flowing into Reserve Banks) was nearly 30 percent higher than in 1998. That number, in turn, was 27 percent higher than in 1997. The strong economy and the public's interest in collecting state quarters were likely contributing factors to the recent higher coin demand.

To address this situation, the Mint increased its coin production to 20 billion coins in fiscal year 1999 from 15 billion in 1998. It also shifted production from pennies to higher-denomination coins to avoid shortages there. Faced with coin orders that exceeded the Mint's near-term production capabilities, the Federal Reserve centralized its management of coin inventories in a single office. Centralized management has allowed the Federal Reserve to coordinate better with the Mint to distribute new coins equitably and balance coin inventories across Federal Reserve sites. In addition, the Mint and the Federal Reserve have encouraged depository institutions to make it easier for the public to deposit coins. We also understand that some depository institutions shifted their coin inventories among their offices to better meet their customers' needs in all geographic areas they served.

Coin circulates much differently than currency. This is especially true for pennies, which do not circulate with the same frequency as other coin denominations. The Mint and Federal Reserve have experienced other periods in the 1980s and 1990s when the demand for pennies exceeded the Reserve Bank inventories and the Mint's production capacity. The location of the coin, not the amount of coin, is quite often the problem. People tend to accumulate coins in desk drawers, jars, or on the tops of dressers. One company identified this phenomenon as a business opportunity and placed coin collection machines in supermarkets. In 1999, this company returned 20 billion coins to circulation.

The Federal Reserve and the Mint are working collaboratively to better understand coin demand and coin circulation patterns. Efforts are under way to develop better models for forecasting coin demand and to improve coin distribution and inventory management systems.

Dollar Coin
The recent introduction of the new dollar coin illustrates the Federal Reserve's role in coin distribution. The original plan, developed last summer, called for the Federal Reserve to begin distributing the new dollar coin to the banking industry in March 2000. Depository institutions, armored carriers, and the Federal Reserve had requested this release date to ensure that any increased currency flows around the Y2K period had diminished before distribution and inventory build-up efforts began for the dollar coin.

In December 1999, the Mint notified the Federal Reserve and banking industry representatives that it planned to enter into a corporate partnership with Wal-Mart to promote the new dollar coin beginning in January. Banking industry representatives objected to a retailer's distributing the new coin before the banking industry obtained it, and they asked that the industry receive the new dollar coin at the same time. The Mint and the Federal Reserve tried to accommodate the depository institutions, but the production and distribution logistics associated with this accelerated schedule made it difficult for the Mint and the Federal Reserve to meet depository institutions' initial orders for the dollar coin.

By January 30, the launch date for the Wal-Mart promotion, the Mint had shipped boxes of wrapped new dollar coins directly to Wal-Mart stores. In contrast, the Mint began limited shipments to the Federal Reserve on January 18, but some West Coast Federal Reserve offices did not receive the coin until January 28, two days after the coin was officially released to the public. Additionally, Wal-Mart received more initial supplies of the new dollar coins than did the Federal Reserve. By February 11, the Mint had shipped 60 million coins to Wal-Mart. In contrast, by the same date, the Mint had shipped 51 million coins to the Federal Reserve, which we used to begin meeting the demand for the rest of the U.S. economy.

Once the Reserve Bank coin facilities received the initial supply of dollar coins, the Reserve Banks equitably distributed the unwrapped dollar coins and partially filled depository institutions' orders through normal armored carrier transportation routes. Depository institutions typically received the new dollar coins several days later to allow time for the armored carriers to wrap the coin and deliver it. Because of the limited initial quantities of coin available to the Federal Reserve, many community banks and branches of large banks did not receive dollar coins until after Wal-Mart had released them to the public.

To address the banking industry's desire to have dollar coin inventories as soon as possible, the Federal Reserve worked closely with the Mint to develop a direct shipment program for depository institutions. This temporary program, managed by the Mint, is designed to expedite delivery of limited quantities of dollar coins to small depository institutions. We expect that within the next few weeks the distribution channels will catch up to initial demand and the Federal Reserve will be able to fill all depository institutions' orders for the new dollar coin.

Anti-Counterfeiting Measures
Although the Secretary of the Treasury, and not the Federal Reserve, has authority to approve currency designs, the Federal Reserve works actively and collaboratively with the Treasury, the Secret Service, and the Bureau of Engraving and Printing on anti-counterfeiting efforts. Counterfeit-deterrent features in U.S. currency continue to evolve to ensure a secure currency in which the public has confidence. Currency design changes in 1990 introduced a security thread, microprinting, and new covert features. The 1996 series design includes both publicly-recognizable anti-counterfeiting features, such as an enhanced security thread, a watermark, and color-shifting ink, as well as additional covert, machine-readable features. The Federal Reserve also provides information to the Secret Service on all counterfeits the Reserve Banks receive in its deposits, including the most sophisticated counterfeits.

Given that about two-thirds of U.S. currency circulates overseas, we monitor and analyze international currency flows and counterfeiting data to understand better the international use of U.S. currency and the incidents of U.S. currency counterfeiting in foreign countries. The Federal Reserve maintains close contact with commercial banks that provide currency internationally as well as with other central banks so that we can closely monitor counterfeiting activity.

Ongoing research efforts are aimed at defending against future counterfeiting threats, especially those posed by continued improvements in, and the low-cost availability of, inkjet printers and computer scanners. For instance, the Federal Reserve and the Bureau of Engraving and Printing have devoted significant resources to a twenty-four nation effort, through the Bank for International Settlements, to combat color copier counterfeiting and, more recently, the growing threat of inkjet counterfeiting.

The Federal Reserve is not active in anti-counterfeiting efforts for coin. Economic loss and the number of counterfeiting incidents associated with coin are low compared with those involving currency. Moreover, because the Federal Reserve's coin processing operations do not include piece inspections, our ability to detect counterfeit coin is limited.

High-Denomination Banknotes
The Subcommittee has asked for our views on the advantages and disadvantages of issuing U.S. banknotes in denominations higher than $100. We considered how a higher-denomination note could enhance the attractiveness of using U.S. currency and could provide savings by reducing printing, processing, and transportation costs. These benefits were weighed against the concern that high-denomination banknotes could facilitate money laundering and drug trafficking.

Demand for U.S. currency and for specific denominations is driven by many factors, including the needs for a medium of exchange and a store of value. Domestic demand for currency is largely transaction-oriented and is influenced by income levels, prices, and the availability of alternative payment methods. Increases in domestic demand for high-denomination banknotes ($50s and $100s) have been generally modest because Americans tend to use checks, credit/debit cards, or other noncash forms of payment for larger-dollar transactions. The introduction of a higher-denomination banknote saves printing and processing costs, but only to the extent that the public shifts its demand from $100s to larger-denomination notes. Even if such a shift occurred, any savings would likely be minimal without a substantial reduction in the demand for other notes -- $1s through $20s account for about 85 percent of the production of the BEP and over 90 percent of the Federal Reserve's processing.

International demand for U.S. currency is influenced largely by the stability of foreign currencies, the confidence in the U.S. dollar as a stable currency backed by a strong economy, and the lack of any recall of U.S. currency. As I mentioned earlier, approximately two-thirds of U.S. currency is held internationally, but about three-quarters of the $100 notes in circulation are held overseas. Foreigners use high-denomination U.S. banknotes primarily for savings, but we also find that countries with transitioning economic and political environments use U.S. currency as a medium of exchange. Ultimately, we believe the strength and stability of our economy will continue to be the primary factors influencing international demand for U.S. currency. Thus, the introduction of a high-denomination U.S. banknote would likely produce minimal increases in demand for U.S. currency.

Although there are some benefits associated with a high-denomination banknote, the law enforcement community has expressed concern about the disproportionate use of large-denomination banknotes for illicit activity including money laundering, drug trafficking, and tax evasion. In addition to making large-value transactions more efficient, a high-denomination note could inadvertently facilitate illegitimate transactions by making them more efficient as well. Such concerns prompted the Canadian government's recent proposal to cease issuing its $1000 banknote.

In weighing the marginal benefits of introducing a high-denomination U.S. banknote against law enforcement concerns about illegitimate activities, we do not foresee any immediate need to issue high-denomination notes.

We appreciate the opportunity to share our thoughts on these issues.

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