Statement by Theodore E. Allison, Assistant to the Board for Federal Reserve System Affairs, Board of Governors of the Federal Reserve System, before the Task Force on Economic Policy, Projections, and Revenues of the Committee on the Budget, U.S. House of Representatives, May 28, 1992.

Statement by Theodore E. Allison, Assistant to the Board for Federal Reserve System Affairs, Board of Governors of the Federal Reserve System, before the Task Force on Economic Policy, Projections, and Revenues of the Committee on the Budget, U.S. House of Representatives, May 28, 1992

I am pleased to have this opportunity to present estimates of the impact on the Federal Reserve System of substituting a one-dollar coin for the one-dollar bank note now in circulation, as would be required by H.R. 1245, the United States One Dollar Coin Act of 1991. In brief, a dollar coin could produce sizable cost savings for the federal government as a whole, for three reasons: First, production costs for dollar coins, over time, would be lower than for dollar notes. Second, Federal Reserve processing costs for incoming coin deposits would be lower than for incoming note deposits. And, third, the Treasury's interest saving as a result of one-dollar coin seigniorage would be greater than the Federal Reserve's interest earnings derived from one-dollar notes (this is true because the number of dollar coins in circulation is likely to exceed significantly the number of dollar notes). These savings would aggregate to about $400 million a year on average, in present value terms, over the next thirty years.

The potential savings can be achieved, however, only if the one-dollar note is withdrawn from circulation. Moreover, the budgetary savings would be even larger--more than $500 million a year if the two-dollar note is not made available.

Before turning to the impact of a dollar coin on the Federal Reserve's financial position and to the specific questions raised in your invitation for this testimony, I would like to explain briefly the ways in which the federal government budget would be affected by issuance of a dollar coin. As will be seen, the budgetary impacts would be somewhat complex, and the overall savings would not come solely--or even predominantly-through the Federal Reserve.

Coins are placed into circulation in a process in which the Department of Treasury (1) mints new coins in accord with the needs of the public (using appropriated budget funds for all but the metal cost), (2) books a"profit" (called seigniorage) equal to the difference between the face value of the coins and their cost of production, which is treated as a means of financing the federal budget, and (3) deposits the coins with the Federal Reserve Banks for credit to the Treasury Department's checking account. Thus, in budgetary terms, production of additional coins would (a) raise budgeted outlays by the Treasury for Mint operations in the year of production and (b) increase seigniorage, and consequently reduce budgeted outlays for interest on the borrowing displaced thereby, in the year of production and in all future years.

The mechanism by which notes are placed into circulation is rather different: (1) The cost of new bank notes enters the federal budget indirectly: New notes are purchased by the Federal Reserve from the Bureau of Engraving and Printing, a unit of the Treasury Department, at a price set to recover the Bureau's full cost of production. The Bureau's expenses are not included in the federal budget. Instead, the Federal Reserve's outlays for production of new notes are assessed against the earnings of the Reserve Banks, thereby reducing the net earnings of the System remitted to the Treasury Department and, accordingly, miscellaneous receipts in the budget of the federal government. (2) The "profit" on the bank note issue also is accounted for differently than the "profit" (or seigniorage) on the coin issue: Bank notes in circulation are a liability of the Federal Reserve Banks for which the Reserve Banks hold corresponding earning assets. Increases (or decreases) in bank notes in circulation would result in higher (or lower) Federal Reserve portfolio earnings and concomitantly higher (or lower) budgetary miscellaneous receipts of the federal government.

As a final budgetary implication, processing incoming deposits of coins is less costly for the Federal Reserve Banks than processing incoming deposits of notes.

To summarize, the federal government budgetary implications would fail into five categories: (1) increased budgetary expenses at the Treasury Department's Bureau of the Mint, which would produce the dollar coins; (2) Treasury interest savings as a consequence of the seigniorage derived from issuing one-dollar coins; (3) reduced Federal Reserve earnings on its portfolio of securities, which would decline as a result of withdrawing one-dollar notes from circulation (and concomitant lower net Federal Reserve earnings paid to the Treasury as a budgetary miscellaneous receipt); (4) reduced costs at the Federal Reserve for purchases of one-dollar notes (net of any increased cost of purchasing two-dollar notes); and (5) reduced costs at the Federal Reserve because processing incoming deposits of dollar coins is more economical than processing incoming deposits of dollar notes. As is clear, these budgetary effects are highly interrelated and therefore should be considered as a whole. Let me now take up the budgetary impacts in turn.

(1) Mint expenses. In the U.S. budgetary system, Mint expenses other than for metal are treated as outlays subject to the budget and appropriations processes. (Metal purchases are made through the Coinage Metal Fund, a revolving account not subject to budget or appropriations.) In manufacturing the replacement stock of nine billion one-dollar coins assumed to be necessary at the outset of the replacement period, the Mint initially would incur onetime budgeted outlays of $164 million (nine billion coins at an assumed $80 per thousand coins times an assumed 20 percent share of the $80 for budgeted operating costs, plus an additional $20 million for design and start-up costs). (The specific assumptions used in estimating these impacts can be found in attachment 1.)(1) Thereafter, the Mint would incur the costs of producing only enough new one-dollar coins to replace those that were lost or mutilated during the year and to satisfy the public's need for growth in the coin stock. The average annual budgeted outlays of the Mint for one-dollar coins, discounted to the present, would be $20 million.

(2) Seigniorage and interest savings. Unlike tax receipts and other governmental receipts, which are compared to governmental outlays in calculating the surplus or deficit, seigniorage-- the difference between the face value and the cost of the year's coin production--is treated as a means of financing a deficit (or of reducing debt in a year with a surplus). Seigniorage thus reduces the Treasury's borrowing requirements in the year in which the coins are manufactured and in every year in the future in which the coins remain in circulation. In manufacturing the nine-billion-coin replacement stock and the smaller annual amounts thereafter, the Treasury would realize seigniorage of $54 billion by the end of the thirty-year assumed life of the coin and would avoid borrowing of the same amount. The average annual interest savings, discounted to the present, would be $430 million per year.

(3) Federal Reserve portfolio earnings. The Treasury will be receiving the Federal Reserve's earnings on assets associated with the stock of six billion one-dollar Federal Reserve notes assumed to be outstanding at the outset of the replacement process. For purposes of the federal budget, these earning are treated as a miscellaneous receipt. If the one-dollar notes were withdrawn from circulation, and perhaps partially replaced by two-dollar notes, there would be a corresponding reduction in the Federal Reserve's portfolio, and the Treasury would lose the Federal Reserve earnings thereon--estimated at $170 million per year, on average, in present value terms.

(4) Federal Reserve new-note costs. Upon introduction of a one-dollar coin, and consistent with the Mint's ability to manufacture the initial replacement stock of one-dollar coins, the Federal Reserve would discontinue its purchases of new one-dollar notes and perhaps increase its purchases of new two-dollar notes. The net savings in new-note costs would increase the Federal Reserve's earnings paid to the Treasury by an assumed average annual discounted amount of $109 million.

(5) Federal Reserve processing costs. Depository institutions deposit at Federal Reserve Banks currency and coin that exceeds their requirements. Note deposits are verified by the Reserve Banks in a process in which each note is counted, examined for authenticity, checked for fitness, and, if unfit, shredded or, if fit, held in the vault for further circulation. Coin deposits, on the other hand, are verified in bulk by weighing-at about half the cost of processing notes. In addition, Reserve Banks would likely receive fewer one-dollar coins from circulation, relative to the quantity in circulation, than they do one-dollar notes. Taking these differences into account, the Federal Reserve would realize discounted average processing-cost savings of $47 million per year.

The total financial impact on the federal government would be the sum of the separate impacts described above--estimated to be a savings of $395 million per year. These impacts have all been expressed as averages of discounted present values of future costs and savings over the thirty-year life of the coin.

I might note that the budgetary savings of $395 million per year assumes that 25 percent of the value of one-dollar notes in circulation would be replaced by two-dollar notes. Those savings would be increased considerably if two-dollar notes were not made available. Our estimate is that, without two-dollar notes, the average annual savings would rise from $395 million to $511 million per year.

You have invited us to address the possible need for an additional currency printing facility for the Bureau of Engraving and Printing if a new one-dollar coin were not introduced. That question is difficult to answer, in part because we understand that the Bureau is developing new, and potentially much more efficient, printing equipment that could increase the capacity of the present facilities significantly and in part because the Fort Worth facility has potential for horizontal expansion. It must be stressed, however, that all three relevant governmental entities--the Federal Reserve System, the Bureau of the Mint, and the Bureau of Engraving and Printing (not to mention the multitude of currency handlers and currency-equipment manufacturers in the private sector)--are involved continuously in long-term planning for facilities and equipment so that they can be prepared to meet efficiently the public's need for currency and coin. Consequently, it is essential that in connection with any one-dollar coin legislation there be an unequivocal commitment to discontinuing circulation of the one-dollar note. Without such a commitment, the uncertainty about future requirements, as we wait for the public's preference to become clear, will inevitably lead the three entities as a whole to overinvest in production and processing equipment.

I appreciate having this opportunity to present our estimates of the budgetary impact of replacing the one-dollar note with a new coin. If you have any questions, I would be pleased to try to answer them.

1. Attachments to this statement are available on request from Publications Services, Board of Governors of the Federal Reserve System, Washington, DC 20551.