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Statement submitted by The Honorable Edward W. Kelley, Jr. Member of the Board Board of Governors of the Federal Reserve System to the Subcommittee on Domestic and International Monetary Policy of the Committee on Banking and Financial Services U. S. House of Representatives May 3, 1995 APR 2 8 1995 The Board of Governors is pleased that the Congress is again considering legislation that would provide for substituting a one-dollar coin for the one-dollar banknote now in circulation, and we appreciate the opportunity to present information on several benefits and costs of making such a replacement. In summary, a dollar coin would produce a substantial budgetary gain for the Federal government, provided that the one-dollar note is withdrawn from circulation. The Board believes, however, that the convenience and needs of the American public, rather than cost savings, should be the main consideration in making this decision. Experience in Canada, where a similar change was made some years ago, suggests that the public will, over time, find a dollar coin more convenient than the dollar note. Finally, we would note that the significance of the U.S. dollar goes beyond the purchasing power it represents or the utility it provides; for Americans, the dollar is a symbol of economic and political stability and a source of national pride; consequently, any change should be made only for the most compelling reasons. If, after taking account of all these considerations, the Congress is inclined toward replacing the dollar note, it should enact legislation with a reasonably delayed effective date so that all those affected can plan adequately for the transition. - 2 - The impact on the Federal budget of issuing coins and currency notes is not widely understood by the public, so it may be useful to devote a part of this statement to reviewing those fundamentals. Although the accounting processes and budget presentations are quite different, in substance: • Both issuing coins and issuing currency notes lower the government's effective cost of borrowing from the public, by approximately the value of the coin or currency notes in circulation times the interest rate that the government pays on its debt. • There is an offsetting cost to the government associated with servicing the outstanding circulating coins or notes, which involves replacing "unfit" coins and notes as they wear out and operating the Federal Reserve currency and coin processing facilities that provide the public with good-quality, genuine coins and notes. Let us start with the following assumptions in order to illustrate the budget and accounting processes: (a) the Treasury's borrowing rate is 5.5 percent; (b) there will be 7 billion $1 notes already in circulation at the time of the changeover; (c) $1 notes have a useful life of 1.5 years and cost 3.8 cents each to produce; (d) $1 coins would have a useful life of 30 years and cost 8 cents each to produce; and (e) $1 notes and $1 coins would cost 75 cents and 30 cents per thousand pieces, respectively, to be processed at Federal Reserve Banks. -3In the issuance of currency notes, the reduction in net governmental borrowing from the public occurs indirectly. The Federal government's total borrowing and total interest outlays are not affected, but the Federal Reserve System holds a portfolio of government securities equal to the value of Federal Reserve notes outstanding and, at the margin, the Federal Reserve returns to the Treasury its full earnings on those securities. These earnings are, from the Treasury's viewpoint, a return of its own interest outlays.1 • In our simplified model, the $7 billion of outstanding $1 notes provides a gross benefit to the Treasury of $385 million per year.2 • The cost of servicing the $1 note issue is the cost of replacing each note every 1.5 years, or $177 million per year,3 and of processing it 1.3 times per year at Reserve Banks, or $7 million per year.4 Thus the net benefit to the Treasury associated with 7 billion of outstanding $1 notes is $201 million per year.5 In the issuance of coins, the reduction in net governmental borrowing from the public occurs directly. When the Treasury deposits newly minted coins at 1 The Federal government budget accounts treat Federal Reserve earnings paid to the Treasury as a miscellaneous receipt. 2 $7 billion x 5.5%. 3 7 billion notes + 1.5 x $.038. 4 7 billion notes x 1.3 x $.00075. 5 $385 million - $177 million - $7 million. -4 Federal Reserve Banks, it receives credit to its checking account, and thus the government is able to make budgeted expenditures without additional borrowing, in the amount of the face value of the newly deposited coins less their production cost (which amount we call "seigniorage"). 6 • Seven billion new $1 coins would reduce the Federal government's total borrowing by $6.44 billion7 and total interest outlays by $354 million per year,8 a gross benefit not much different from the gross benefit from 7 billion notes. • But the cost of replacing each coin every 30 years would be only $19 million per year9 and of processing dollar coins at Reserve Banks 0.3 times only $1 million per year.10 6 The budgetary accounting process for coin production sometimes gives rise to the belief that the booking of seigniorage per se reduces the Treasury's borrowing requirement. This is not so. It is being able to spend the newly minted coins that reduces the Treasury's need to borrow. Such spending seldom occurs directly, of course; the Treasury ordinarily deposits newly minted coins at Federal Reserve Banks for credit to its checking account. Reserve Banks accept only as many new coins as they expect to need in order to meet the requirements of depository financial institutions in their districts. 7 $7 billion face value - $560 million production cost. 8 $6.44 billion x 5.5%. 9 7 billion coins •+• 30 x $.08. 10 7 billion coins x 0.2 x $.00030. Note that $1 notes are typically deposited at Federal Reserve Banks an average of 1.3 times per year. We expect that $1 coins would be deposited only 0.2 times. -5Thus the net benefit to the Treasury associated with 7 billion of outstanding $1 coins would be $334 million per year," considerably higher than that for an equal number of currency notes. At this point in the analysis, replacing $1 notes with $1 coins would have a favorable impact on the governmental budget of $133 million per year.12 However, such a replacement would have a further-and even more significant-benefit. Based on the experience in virtually every country that has made a comparable substitution, the government can expect to issue at least twice as many $1 coins as it would have issued $1 notes.13 (This may result partly from the habit of many people to save their pocket change at the end of the day and partly from a tendency for banking and retail establishments to hold larger quantities of coins than of notes of equal value.) In our simplified model, doubling the number of $1 coins in circulation would add another $334 million per year to the Treasury's benefit, for a total benefit of $467 million. These effects are summarized in the following table. 11 $354 million - $20 million. 12 $334 million - $201 million. 13 In six countries that replaced a note valued at about one dollar with a coin, the General Accounting Office found coin-for-note replacement rates ranging from 1.6-to-1 to 4-to-1. General Accounting Office, NATIONAL COINAGE PROPOSALS. Limited Public Demand for New Dollar Coin or Elimination of Pennies. May 1990, page 39. - 6 - $1 note $1 coin Difference Reduction in net governmental borrowing from the public $7.00 billion $6.44 billion Reduction in net governmental interest outlays, annually $385 million $354 million $ 31 million (in favor of note) Cost of maintaining the outstanding issue, annually $184 million $ 20 million $164 million (in favor of coin) Net benefit based on 6 billion notes vs. 6 billion coins, annually $201 million $334 million $133 million (in favor of coin) $334 million $334 million (in favor of coin) $668 million $467 million (in favor of coin) Additional benefit from twofold replacement rate, annually Total benefit based on 6 billion notes vs. 12 billion coins, annually $201 million Table 1 A Simplified Outline of the Impact on the Federal Government Budget Of Substituting $1 Coins for $1 Notes The simplified model, of course, does not fully reflect the real world. There are factors that would both increase and decrease the $467 million annual benefit shown above. In particular, growth in the volume of $1 currency pieces outstanding-historically, over 4 percent per year-would, over time, considerably increase the benefit of substituting coins for notes. So would any numismatic, or sentimental, collecting of $1 notes that might result from the announcement that they soon would no longer be issued (although $1 notes would continue to be legal tender). On the other hand, some increase in the use of $2 notes by the public - 7seems very likely if the $1 note were no longer issued, and any such increase would reduce the budgetary gain. In addition, the production cost for higher denomination notes would rise because fixed costs at the Bureau of Engraving and Printing would be spread over a smaller production volume. (One dollar notes account for nearly 50 percent of the total annual currency note production.) Taking account of these additional factors, the Board's staff estimates that, in the first five years of the implementation, the Federal government budget position would be improved by a total of $2.28 billion (in nominal terms). The average yearly gain in real present-value terms, over the assumed thirty-year life of a $1 coin is estimated to be $460 million.14 These gains are unlikely to be achieved, however, if the dollar note is not withdrawn from circulation. This is because the private sector (notably banking and retail establishments), not knowing how extensively the public will use the dollar coin, will be reluctant to make the infrastructure outlays necessary for the coin to succeed (training employees on new cash-register-drawer procedures, ordering of dollar coin inventories, new arrangements with financial institutions, and the like). Likewise, the public will refrain from using the new coin if the retail 14 The 30-year estimate uses an inflation rate of zero, a Treasury borrowing rate of 3 percent, and a rate for discounting future values to the present of 3 percent. The advantage of expressing the longer-run financial impacts in real present-value terms is that it adjusts for inflation and the time value of the magnitudes involved. - 8 - sector is not prepared.15 In the meantime, the public sector (particularly the Bureau of Engraving and Printing, the Bureau of the Mint, and the Federal Reserve System; perhaps also the Postal Service and mass transit systems), not knowing what the respective demands will be for dollar notes and coins, and wanting to be able to meet any likely demand, will inevitably overinvest in production and processing capacity. As important as the budgetary gains would be, the Board believes that the foremost consideration in this decision should be the convenience and needs of the public. In this regard, opinion surveys indicate that the American public generally is satisfied with the present currency system and may not initially welcome replacing the one-dollar note. There is evidence in the Canadian experience, however, that over time a dollar coin would come to be recognized as more convenient, cleaner, and more efficient than the one-dollar note. If designed properly, a dollar coin may well be able to evoke confidence in the currency system and be a source of national pride to the same extent that the dollar note does now. Market testing, such as with focus groups, can help to achieve this result. 15 See The Susan B. Anthony Dollar and the Theory of Coin/Note Substitutions, by John P. Caskey and Simon St. Laurent, Journal of Money, Credit, and Banking, Vol. 26, No. 3 (August 1994, Part I), for an excellent treatment of "network externalities" in currency systems. - 9 We believe that some legislative proposals, such as H.R. 534, would not provide enough preparation time for those most involved-the Nation's banking and retail establishments, the Treasury Bureaus of the Mint and of Engraving and Printing, and the Federal Reserve Banks. Preparing for the issuance of new $1 coins will be complex and time consuming, and the prescribed preparation period--18 months-would not be sufficient. The Mint will need time to be certain that the design is effective, both mechanically and in terms of public acceptance. There will be substantial changes in resource requirements at the Bureau of Engraving and Printing, the Bureau of the Mint, and the Federal Reserve Banks and branches. And, above all, the Nation's banks and retail establishments will have to plan carefully for the changeover. Moreover, beginning in 1996, the Treasury and Federal Reserve will begin a multi-year introduction of new designs for Federal Reserve notes that will be completed (with the introduction of a newly-designed $5 note) in about 1999. It would be preferable that these important changes not occur contemporaneously with the introduction of a dollar coin. A reasonable approach may be for the Congress to explore thoroughly the implications~for the Federal budget, for the convenience and needs of the public, and for the public's feelings toward the currency-of replacing the $1 note with a coin. If the Congress judges that the balance of considerations weighs in - 10 - favor of replacing the note, it should adopt legislation as promptly as possible that would establish dates in the future for introducing the new $1 coin, say in about four years to coincide with issuance of the newly designed $5 note, and for no longer issuing $1 notes. In that way, both the public and private sectors would have a sound basis for beginning immediately to plan for the change.
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